Summer Reading III

by Jerry O’Driscoll

According to Reinhart and Rogoff, “for the advanced economies during 1800-2008, the picture that emerges is one of serial banking crises.” In This Time is Different, the authors bring us up to the present by examining the history of banking crises. Banking crises are not only frequent , but often accompanied by other kind of crises.  These include exchange rate crises, domestic and foreign debt crises and inflation crises.  The current financial crisis is still unfolding, but we have already seen the clustering of crises.

They observe that banking crises are often preceded by surges in capital flows.  This finding may be controversial, but they detail it at length.

Banking crises are often associated with an asset bubble in housing. They compare the current housing and banking crises to others stretching back to one in Norway during 1898-1905. They devote considerable time to inflationary crises, which are quite common aftermaths both in earlier and more recent history (1500-1799 and 1800-2008).

That brings them to the subprime meltdown and what they term “the Second Great Contraction” (after the great Contraction, 1929-33).  It is an excellent and thorough presentation. They note historical studies calling into question the Fed’s policy of “benign neglect” toward the housing bubble under Greenspan and Bernanke.

The history of the aftermath of banking crises is sobering.  One salient fact: in the aftermath of 21 banking crises involving a housing boom and bust, real housing prices declined on average 35.5% over 6 years. By that record, we are but halfway through the housing bust. They find that “for banking crises, real housing prices are nearly at the top of the list of reliable indicators” (p. 279).  Once again, the Fed’s attitude toward the boom in housing prices is called into question by historical experience.

I recommend this book to all for serious summer reading.

9 thoughts on “Summer Reading III

  1. Re “Once again, the Fed’s attitude toward the boom in housing prices is called into question by historical experience.”

    There is the Greenspan defense that bubbles can’t be identified before the burst & in any case can’t be stopped without causing substantial economic pain.

  2. Chidem,

    What the history reveals — as sound theory predicts — is that a policy of easy money leads to housing booms and busts. The way a central bank avoids the pain of a bust is to avoid creating the boom. And it does that by prudent policy.

  3. Jerry,
    Your argument sounds eminently reasonable to me. Instead of taking away the punch bowl the Fed spiked it!

    However, Alan Greenspan has repeatedly argued that he as Fed Chair could not have avoided the boom without inflicting pain that might have been as bad as or even worse than what was to come–or so I understand his various comments. And what was to come was uncertain, so inflicting the pain was unjustified.

    Obviously this is his defense. But I wonder if there is more to it. Just raising the question.

  4. Chidem Kurdas: Greenspan’s defense seemes weak.

    Deflating a bubble is much easier and cheaper if done earlier than later. Distortions, financial and real, need years to develop and spread throughout the economy. Financial systems do not suddenly start using 3 months funding for 30 years loans, consumers do not suddenly develop a 100% debt/GDP ratio, the personal saving rate doesn’t instantly fall to zero from 10% in a day, entreprenurs do not start long-term plans for a single policy shock, and the trade deficit doesn’t grow to 8% of GDP, funding 50% of investments, unexpectedly. The longer the boom, the worse the recession.

    Does Greenspan want someone to believe that stopping the boom in 1993 would have been as difficult as in 2007?

    No boom can be painlessly stopped, but the more it goes on and the worse will be the unavoidable crisis.

  5. As far as avoiding the boom goes, I really wish we had a central bank with the humility to explicitly institute a Taylor-rule like system. I think this would go a long way towards avoiding/mitigating future crises.

    PS, I am also reading Rogoff’s book–I agree it is exceptionally informative.

  6. […] and it looks like there’s a whole new world where the old strictures no longer apply—-see Jerry O’Driscoll’s review of This Time is Different by Reinhart and Rogoff. It looks that way not just to bankers but also to […]

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