Academic journal article Contemporary Economic Policy

International Evidence on Recovery from Recessions

Academic journal article Contemporary Economic Policy

International Evidence on Recovery from Recessions

Article excerpt

1. INTRODUCTION

The objective of this article is to present a series of stylized facts on how countries recover from recessions. (1) Recent literature demonstrates that negative shocks, particularly financial crises, can generate a sizeable permanent loss in the level of output compared with the pre-crisis trend (Cerra and Saxena 2008). According to this literature, the persistent impact on the trend holds for advanced, emerging market, and developing countries, on average. (2) This finding challenges the standard textbook conception of the business cycle, depicted as a transitory deviation around a stationary trend. It also questions whether the finding that the U.S. economy rebounds from recession (Kim, Morley, and Piger 2005) can be generalized to countries outside the United States.

This article relates to the recent literature which studies the frequency and output losses associated with different types of shocks across different groups of countries and the determinants of the duration of output contractions. For example, Becker and Mauro (2006) document the frequency, duration, and overall output costs (measured as the cumulative yearly output losses relative to the preevent GDP per capita) of various real, financial, and sociopolitical shocks. They find that financial and macroeconomic shocks are among the most costly for emerging market countries and terms of trade and interest rate shocks are the most costly for developing countries. Kaminsky and Reinhart (1999) provide an event study of banking and balance of payment crises, demonstrating the behavior of macroeconomic variables in a 3-year window around the event as well as variables that best signal an impending crisis. Cerra and Saxena (2005a) show that half of all economic contractions are associated with political or financial crises, and the higher incidence of crises in lower income countries is an important reason for unconditional divergence in the post-war growth data. Hausmann, Rodriguez, and Wagner (2006) find that countries enter growth collapses for multiple reasons, including wars, export collapses, sudden stops, and political transitions, but that most of these variables do not help predict the duration of crises episodes. Instead, they find that a measure of the density of a country's export product space is significantly associated with lower crisis duration.

This literature on the signals, depth, and duration of recessions pays less attention to how the recovery rate and persistence are affected by the policy responses and structural features of countries. We fill that gap in this article by focusing on the period of economic recovery after a recession, and studying the macroeconomic policies that influence recovery. Of course, endogeneity issues are a standard concern in analyzing policy effectiveness. Therefore, Section III discusses these issues in depth, first in terms of the general concepts and later with respect to how endogeneity issues may affect each of the results. For example, we note that the endogeneity of fiscal and monetary policies with growth would be likely to bias results against finding evidence of policy effectiveness, such that any evidence that emerges is likely to be a lower bound on effectiveness. In contrast, donor behavior in providing aid may bias results toward finding effectiveness.

Asymmetry in the business cycle--the idea that recessions are different from expansions--has been emphasized by scholars dating back at least to Mitchell (1927). In particular, recessions are characterized as abrupt, violent, but short-lived contractions, juxtaposed to smoother and longer-lived expansions. Modern time series econometricians have formalized these ideas by developing models in which economic behavior depends on regime switching among states governed by different transition probabilities (Hamilton 1989). Recently, Lo and Piger (2005) extend the idea to asymmetries in the response of U. …

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