The process of economic adjustment following financial crises: a historical perspective

The severe financial imbalances generated in the advanced economies during the preceding upturn are at the root of the current crisis and explain why, since 2008, a large number of developed countries have experienced the deepest recession of recent decades and why the recovery is taking place at such a slow pace. Chart 1 shows the strong contraction in GDP growth and the notable rise in the rate of unemployment in the cases of the United States, the United Kingdom and the euro area. The economic literature shows that recessions associated with financial crises are especially acute and prolonged. Studies underline that recessions associated with financial crises are the result of excessively optimistic expectations regarding the growth of income and wealth, which lead to a very pronounced expansion in the borrowing and leverage of private agents. When these expectations fail to materialise there is a sudden correction of private spending, which is all the greater the more extensive the imbalances that have built up in the private sector, and the subsequent economic recovery should preferably be supported by government and foreign demand, while firms and households rebuild their financial position. As seen in Chart 1, following the start of the current crisis, the private sector’s saving-investment balance has recovered significantly, while public sector finances have deteriorated, as a result of the operation of automatic stabilisers and the adoption of discretionary fiscal measures designed to reduce the impact of the recession. Given the observed similarity of the economic dynamics of different countries in the current episode, this article analyses the extent to which this pattern of adjustment is in line with the historical evidence of previous crises and the foreseeable course of developments in the current recovery. It does this using a database with information on 46 financial crises during the period 1980-2008, and the dynamics of the main macroeconomic variables following the start of a crisis are studied. The characteristics of the phases of recovery of economies following a recessionary period largely depend on the nature of the expansion that preceded the recession (and, therefore, on the imbalances in the economy) and the prevailing macroeconomic policy framework. Consequently, this article explores the differences in the profile of recovery following a financial crisis in terms of the external position of the economy (current-account deficit or surplus) and the exchange rate regime in force at the beginning of the crisis. The degree of synchronisation of crises is a factor that has a decisive influence on the profile of the recovery. This is an additional obstacle in the current juncture, since the recession has become global and many advanced economies are still handicapped by imbalances. Indeed, the more global the crisis, the smaller the potential role of external demand in the exit phase. The episodes included in the sample of financial crises used in this article did not have the geographic scope of the current one, which has been compared to the Great Depression of 1929-33 (the last great global financial crisis). That crisis led to a prolonged economic stagnation and continues to be an important reference in the design of macroeconomic policies. For this reason, a box is included reviewing the origin and evolution of the 1929 crisis, with special emphasis on the United States, then the central axis of the international monetary system, and the role of macroeconomic policies and the gold standard in the genesis and resolution of that crisis. The comparison of the current recovery with other financial crisis exit phases may allow the short and medium-term growth prospects to be better assessed and the difficulties the advanced economies are having in restoring sustained growth rates similar to the pre-crisis ones to be explained.