During this presidential election cycle, economics and politics are inseparable. The fundamental question voters will have to decide upon when making their choice for President in a few short weeks is whether they believe that the weak recovery we have been experiencing is due to poor economic policies put forth by President Obama or unavoidable circumstance. While polls have consistently shown that voters lay blame for the financial crisis at the feet of President Bush, it is unclear whether they blame President Obama for the weak recovery that followed.
Politically, it’s a tough case to make that 7.8% unemployment, and a per-capita GDP that is still below it’s 2007 peak, is about as good as we could have expected at this point. But the President does have some rigorous economic research to back up such a claim. In 2009, economists Kenneth Rogoff and Carmen Reinhart published a book based on years of research leading up to and during the crisis, called This Time is Different, which argued that contractions caused by financial crises are more painful and take longer to emerge from than normal recessions. These economists accurately predicted the financial crisis months before it happened, and their research – which studies financial crises around the world as far back as the Florentine banking crisis of 1340 – also predicted that we would experience a distressingly slow recovery.
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The reason why recessions triggered by financial crises are so difficult to work through is that these downturns occur after debt-fueled bubbles have burst, when governments, corporations, and households are not only left with large amounts of debt, but also declining income with which to pay it off. And this is exactly what we’ve seen so far in this latest crisis.
But in recent weeks, several conservative economists — some of whom are associated with the Mitt Romney campaign — have emerged to challenge this prevailing theory that systemic financial crises somehow consign us to years of stagnant economic growth. These economists, including John Taylor, Kevin Hasset, and Glenn Hubbard, point to a recent study by Michael Bordo of Rutgers University and Joseph Haubrich of the Federal Reserve Bank of Cleveland, which argues that recessions followed by financial crises actually tend to lead to strong recoveries. According to an op-ed in the Wall Street Journal by Mr. Bordo:
“We found that recessions that were tied to financial crises and were 1% deeper than average have historically led to growth that is 1.5% stronger than average . . .By contrast, the Reinhart/Rogoff analysis focuses on how long it takes the economy to return to its precrisis output level. Since contractions related to financial crises are generally deeper and longer than other recessions, they are followed by recoveries that take longer than normal to see output return: Since 1887, the growth of real GDP over both the recession and the recovery was 1.2% in recessions with financial crises and 2.2% in those without. But that says little about how fast the economy grows once the recovery starts. As we found, since the 1880s, the average annual growth rate of real GDP during recoveries from financial-crisis recessions was 8%, while the growth rate from nonfinancial-crisis recessions was 6.9%.”
The main point of difference between these studies is that Reinhardt and Rogoff are measuring the years it takes – once a recession begins – to regain peak per-capita GDP as well as peak employment. And by this measure, the U.S. is actually fairing better than previous crises. But what Bordo and Haubrich are measuring is the rate of recovery, in terms of GDP growth, once the recovery has begun. And by this measure, the 2007 crisis is indeed a laggard compared to financial-crisis-induced recessions.
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But this seems to me a trivial observation, for the simple reason that the 2007 recession has been much less severe than others that followed banking crises, like 1929, 1907, or 1893. If your recession isn’t as severe in it’s downturn, the recovery won’t be as robust on the way back up. This is because an economic recovery is just what it sounds like: growth that returns an economy back to its long-run trajectory. As Reinhardt and Rogoff write in a recent Bloomberg op-ed, “An 8 percent decline followed by an 8 percent increase doesn’t bring the economy back to its starting point.”
This is such an obvious distinction, that economists who trumpet Bordo and Hubrich’s paper as evidence that the current administration’s policies aren’t working appear to be purposefully muddying the waters of accepted economic theory. This is the line that Paul Krugman took in the New York Times on Monday:
“Look, economics isn’t as much of a science as we’d like. But when there’s overwhelming evidence for an economic proposition — as there is for the proposition that financial-crisis recessions are different — we have the right to expect politicians and their advisers to respect that evidence. Otherwise, they’ll end up making policy based on fantasies rather than grappling with reality.”
Now, Paul Krugman isn’t the best advocate out there for keeping politics and economics separate, but I think his point should be heeded. It is clear that conservative economists on the Romney payroll are trying to dismantle an idea that the available evidence clearly supports — that it takes a long time for a nation to recover from financial crises. Take an August op-ed by Romney-advisors Kevin Hassett and Glen Hubbard in The Washington Post, for instance:
“Michael Bordo of Rutgers University and Joseph Haubrich of the Federal Reserve Bank of Cleveland concluded after an extensive study of recessions in the United States that, contrary to the findings of Reinhart and Rogoff, recessions stemming from financial crises in the United States tended to be followed by faster recoveries. Bordo and Haubrich point out that the 2007-09 recession is actually a negative outlier.”
That quote makes it seem that the Bordo and Haubrich study argues that prior to 2007, America has recovered (reached pre-crisis economic conditions) from banking-crisis-led recessions in a shorter time period. And that is plainly not true. But these two economists aren’t trying to further the general public’s understanding of important economic issues. They are, rather, using their academic reputations to achieve political ends.
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Not that there aren’t plenty of valid critiques of the administration’s economic policy to make. In the same piece, Hubbard and Hassett argue that it was clear that the Obama administration did not understand the nature of economic crisis we faced in 2008:
“The administration’s previous policies are questionable if one accepts that Reinhart and Rogoff are correct and that we are destined for a protracted recovery . . . If the Obama administration believes that the Reinhart and Rogoff analysis is correct, then the White House should concede that it was mistaken when it proposed a stimulus that would boost growth for only a short time, and it should stop calling for marginal hikes in tax rates.”
Of course, this is a completely different argument, and one that the available evidence suggests is more credible. The administration did misinterpret the extent of the crisis. And mainstream economic theory would suggest that cutting any spending or raising any taxes would not be a good idea in the short term. But this isn’t the path that the Romney economic team is advocating either. And its much easier to argue that your opponent has screwed up what would otherwise have been a robust recovery than to admit that we are likely to face more years of slow growth and frustratingly high unemployment, regardless of who wins the presidency.