Romer on Reinhart-Rogoff

The Reinhart-Rogoff study emphasizes common patterns across crises. It eschews complicated statistical techniques, relying instead on simple graphs and averages. And the averages are stunning. For 14 major crises since 1929, the associated decline in real per capita gross domestic product averaged 9.3 percent. For postwar crises, it took an average of 4.4 years for output to return to its pre-crisis level.

But study their charts more closely and you’ll find that those averages mask remarkable variation.....

What explains the variations? Crises don’t happen in isolation. They’re often accompanied by other factors, which differ across episodes. For example, financial crises that happen along with currency crises tend to be followed by much more severe recessions.

Likewise, some panics follow particularly big declines in house and stock prices, which have damaging effects on their own. The most recent recession would likely have been severe — and the recovery slow — even if the financial system hadn’t been stressed, simply because of the decline in wealth and the climb in household indebtedness.

BUT an even larger determining factor is the policy response. Why was the Great Depression so much worse here than in Spain? According to an influential paper by Ehsan Choudhri and Levis Kochin, Spain benefited from not being on the gold standard. Its central bank was able to lend freely and increase the money supply after the panic. By contrast, in 1931, the Federal Reserve in the United States raised interest rates to defend its gold reserves and stay on the gold standard, setting off further declines in output and exacerbating the banking crisis.

Likewise, the policy response largely explains why output fell after the American banking panics in 1930 and 1931, but rose after the final wave in early 1933. After the first waves, the Fed did little, and President Herbert Hoover signed a big tax increase to replenish revenue. After the final wave, President Franklin D. Roosevelt abandoned the gold standard, increased the money supply and began a program of New Deal spending....

Read the whole post at The New York Times
A Financial Crisis Needn’t Be a Noose

Christina D. Romer, economics professor at the University of California, Berkeley, and former chairwoman of President Obama’s Council of Economic Advisers

So close and yet so far.