All Just a Little Bit of History Repeating

February 16, 2009


“The first major financial crisis of the 21st century involves esoteric instruments, unaware regulators, and skittish investors. It also follows a well-trodden path laid down by centuries of financial folly. Is the “special” problem of sub-prime mortgages this time really different?”

This is the opening paragraph from  an interesting paper which compares the current financial crisis to data the authors have compiled on hundreds of previous financial crises.  They find that the current crisis bears a striking resembelance to not just one, but 18 (yes, 18!) previous financial crises in advanced industrialised economies.

So how is this crisis similar, and how is it different?  And what can we learn about the likely impacts and length of this crisis based on the historical record?   First, the authors find that this crisis is striking in its similarity to previous crises on two important metrics: the increase in housing and equity prices which proceeded it and the deceleration of growth prior to the crisis.   In almost all cases, house and equity prices look inflated just before a crisis hits (though housing prices in the US were slightly more inflated this time than the historical average), and growth slows down.

This crisis differs in so far that public debt was lower before this crisis than in other major cases, but the current account balance was much worse.  On average, the current account deficit is about  2% of GDP while the US was running a current account deficit of more than 6%.

With regards to the paper’s predictions about durability of the crisis, they find that on average, crises have an impact of approximately two years and that the severity of the crisis depends a lot both on the “trauma” to the financial system and the policy response. My previous post on the importance of old ideas in alieviating financial crises seems to me to be quite salient: the more than policy makers make use of historical comparisons such as those made in this paper, the more they will have a sense of policy responses which were successful and those that were not.  What is not helpful is believing that this crisis is somehow singularly different than every crisis that has proceeded it, or comparing it only to the Great Depression.

Unfortunately, financial crises happen often, even in advanced economies.   They tend to happen when flows of capital are most liberal, and when commodity prices are falling (these are insights from a larger dataset by the same authors which looks at eight centuries of financial crises) .  The de facto liberalisation of the US financial market, via light regulation and increasingly risky and non-transparent financial instruments, is a contributor to this crisis, just as it has been for financial crises for more than 800 years..


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