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Sovereigns versus Banks: Credit, Crises, and Consequences

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  • Òscar Jordà
  • Moritz HP. Schularick
  • Alan M. Taylor

Abstract

Two separate narratives have emerged in the wake of the Global Financial Crisis. One interpretation speaks of private financial excess and the key role of the banking system in leveraging and deleveraging the economy. The other emphasizes the public sector balance sheet over the private and worries about the risks of lax fiscal policies. However, the two may interact in important and understudied ways. This paper examines the co-evolution of public and private sector debt in advanced countries since 1870. We find that in advanced economies significant financial stability risks have mostly come from private sector credit booms rather than from the expansion of public debt. However, we find evidence that high levels of public debt have tended to exacerbate the effects of private sector deleveraging after crises, leading to more prolonged periods of economic depression. We uncover three key facts based on our analysis of around 150 recessions and recoveries since 1870: (i) in a normal recession and recovery real GDP per capita falls by 1.5 percent and takes only 2 years to regain its previous peak, but in a financial crisis recession the drop is typically 5 percent and it takes over 5 years to regain the previous peak; (ii) the output drop is even worse and recovery even slower when the crisis is preceded by a credit boom; and (iii) the path of recovery is worse still when a credit-fueled crisis coincides with elevated public debt levels. Recent experience in the advanced economies provides a useful out-of-sample comparison, and meshes closely with these historical patterns. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19506.

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Date of creation: Oct 2013
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Publication status: Forthcoming: Sovereigns versus Banks: Credit, Crises, and Consequences , Òscar Jordà, Moritz HP. Schularick, Alan M. Taylor. in Sovereign Debt and Financial Crisis , Kalemli-Ozcan, Reinhart, and Rogoff. 2014
Handle: RePEc:nbr:nberwo:19506

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Credit, Crises, and Consequences
    by noreply@blogger.com (Carola Binder) in Quantitative Ease on 2013-10-14 00:02:00
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Cited by:
  1. Perugini, Cristiano & Hölscher, Jens & Collie, Simon, 2013. "Inequality, credit expansion and financial crises," MPRA Paper 51336, University Library of Munich, Germany.
  2. Obstfeld, Maurice, 2013. "On Keeping Your Powder Dry: Fiscal Foundations of Financial and Price Stability," CEPR Discussion Papers 9563, C.E.P.R. Discussion Papers.

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