Seven More Years of Weak Economy?

Busy today so let me point you to Robert Shiller's discussion of the rather depressing conclusions of some economists who have studied past crises:

But now the Reinharts and Rogoff have systematically studied many more examples in modern financial history. There is also the world financial crisis that attended the oil shocks of 1973 and 1979, and there are the country-specific financial crises in Spain in 1977, Chile in 1981, Norway in 1987, Finland and Sweden in 1991, Mexico in 1994, Indonesia, Korea, Malaysia, the Philippines, and Thailand in 1997, Colombia in 1998, and Argentina and Turkey in 2001.

So, there are many more than just two modern cases (though they are not all entirely independent, because they are somewhat bunched in time). From them, the Reinharts and Rogoff found, for example, that median annual growth rates of real per capita GDP for advanced countries were one percentage point lower in the decade following a crisis, while median unemployment rates were five percentage points higher.

How did this happen? They note that, in general, debt levels and leverage rose during the decade preceding these crises, propelling increases in asset prices for a long time. Reinhart and Rogoff describe a “this time is different syndrome” during the pre-crisis boom, whereby these bubbles are allowed to continue for far too long, because people think that past episodes are irrelevant.

There seems to be the germ of a new economic theory in the work of the Reinharts and Rogoff, but it remains ill defined. It seems to have a behavioral-economics component, since the “this time is different syndrome” seems psychological rather than rational. But it is still not so sharp a theory that we can really rely on it for making confident forecasts.

Moreover, there are reasons to suggest that this time really might be different. I hate to say so, not wanting to commit the sin defined by their “syndrome,” but this time might be different because all of the modern examples of past crises came during a time when many economists worldwide were extolling the virtues of the “rational expectations” model of the economy. This model suggested that a market economy shou

ld be left alone as much as possible, so that is what governments tended to do.