The Reagan and Obama Years

As the economic recovery continues to lag behind expectations, scholars (and some others) have begun to compare this recession and recovery to previous recessions. Notably, Michael Boskin released a piece in the WSJ last week detailing the sluggish growth and comparing the recovery to those during both the Ford and Reagan Administrations. This is not the first in a list of pieces comparing this recession and recovery to Reagan (Richard Rahn also wrote a recent piece for the Washington Times, among others) but Boskin's piece lays out the best comparison we've seen.

The comparison between the Reagan years and the Obama recession is an interesting one for many reasons. As Scott Winship has documented, employment losses appear roughly comparable in both recessions when properly measured. However, as Boskin points out, the recovery after the Ford-era and Reagan-era recessions was far quicker than the recovery in the latest recession:

“Compared to the 6.2% first-year Ford recovery and 7.7% Reagan recovery, the Obama recovery at 3% is less than half speed. The unemployment rate would now be 8% or lower at those higher growth rates. If the Obama recovery continues at 3%, the president will be running for election in mid-2012 with a cumulative GDP recovery shortfall of 4.5% (relative to Ford) to 8.4% (relative to Reagan).”

In the last month, some have taken exception to the comparison, arguing instead that this recession is unique, coming as it does after a major financial collapse. Ken Rogoff and Carmen Reinhart, co-authors of a recent book about financial crises, have argued that recoveries after such crises are by necessity slower and more drawn-out. In a separate interview, Reinhart herself makes this point.

Yet recent research by economists David Lopez-Salido and Edward Nelson at the Federal Reserve Board calls into question the ideas that: 1) recoveries after financial crises are unusually slow; and 2) that the recent crisis represents a unique post-war instance of financial collapse.

In 1982, the U.S. banking sector was in a period of severe stress, sparked by concerns that several Latin American countries would default on sovereign debt held by American banks. This was followed by an elevated rate of bank failures. These failures in turn led to interventions by the FDIC, as well as government interventions in banks like Continental Illinois Bank (which faced a bank run).

By many measures, the events in the early 1980s constituted more of a financial crisis than events post-2007. In that earlier period, institutions facing default and failure were directly responsible for financial intermediation in the real economy. By contrast, the most recent crisis has largely impacted non-bank financial institutions like Bear Stearns or AIG. These firms, though important, were not directly responsible for supplying credit into the financial system.

Lopez-Salido and Nelson also find other periods in American history – from 1973-1975, and 1988-1991 – marked by severe financial stress. But Rogoff and Reinhart isolate the latest period as the lone example of a post-war American financial crisis. Interestingly, the economic recovery was surprisingly brisk in all three of the periods cited by Lopez-Salido and Nelson. This includes the recovery in the Reagan recession, which was on the same trajectory as recoveries prior to 1983.

So, what does this mean in terms of evaluating America’s recovery after deep recessions? For one, it does not necessarily imply that events in the financial sector don’t matter at all. Policy responses to bank failure in the past have consisted of shutting down failed banks and recapitalizing the ones that survive.

Yet, our current policy has extended Too-Big-to-Fail guarantees, while allowing struggling banks to survive, and may induce a Japan-style zombie banking problem. Even if weak recoveries after financial crises are not a typical problem in America, Rogoff and Reinhart’s work suggests that they certainly are in other countries (such as Japan), and America may be moving toward a similar phenomenon.