Reinhart and Rogoff: The Aftermath of Financial Crises

Reinhart, Carmen, and Kenneth Rogoff. 2008. The Aftermath of Financial Crises. NBER Working Paper (December 19).

In an earlier publication, these authors explored a variety of factors relating to the US economy. All of these indicators pointed towards the onset of a financial crisis. This paper also uses history to explore current events by looking at what happens to economies after a banking crisis has occurred.

This analysis includes some emerging countries that have experienced financial crises. The argument is that there is not a very substantive difference between the characteristics of those crises and the crises that strike more financially complex nations.

In general, there are three characteristics that can be inferred form the aftermath of a financial crisis: "First, asset market collapses are deep and prolonged...Second, the aftermath of banking crises is associated with profound declines in output and employment...Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post-World War II episodes...In fact, the big drivers of debt increases are the inevitable collapse in tax revenues that governments suffer in the wake of deep and prolonged output contractions, as well as often ambitious countercyclical fiscal policies aimed at mitigating the downturn" (2).

Decline in house prices is explored. In financial crises, there is typically a decline of about 35.5% in house prices from the peak to the trough of the contraction. The average length of time that the decline is experienced is 6 years. In terms of equity prices, there is an average drop of 55.9% and an average duration of 3.4 years. In terms of unemployment, there is an average increase of 7% and a duration of 4.8 years. Decrease in Real GDP averages 9.3% with an average duration of 1.9 years. After three years, there is an average governmental debt increase of 86%.

"How relevant are historical benchmarks for assessing the trajectory of the current global financial crisis? On the one hand, the authorities today have arguably more flexible monetary policy frameworks, thanks particularly to a less rigid global exchange rate regime...On the other hand, one would be wise not to push too far the conceit that we are smarter than our predecessors" (10).