What’S the Damage? Medium-Term Output Dynamics After Banking Crises

Abstract

This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.This paper investigates the medium-term behavior of output following banking crises, and its association with pre-and post-cr isis conditions and policies. W e find that output tends to be depressed substantially follo wing banking crises, with no rebound to the precrisis trend. However, growth does eventually te nd to return to its pre crisis rate, with substantia l crosscountry variation in outcomes. The depressed path of output typically results from reductions of roughly equal proportions in the em ployment rate, the capital-to-labor ratio, and total factor produ ctivity. Initial cond itions that are strongly as sociated with m edium-run outpu t losses include the short-run change in output, the occurrence of a joint banking-and-currency crisis, and a high precrisis level of investm ent. Short-run fiscal and m onetary stim ulus is associated with smaller medium-run deviations of output and growth from the precrisis trend.

On the Interaction Between Economic Growth and Business Cycles

“…In turn, the results of the AMG estimation including the CDP as an explicit regressor as depicted in equation (11) (henceforth AMG [1]) and imposing the CDP with unit coefficient as depicted in equation (12) (henceforth AMG [2]) can be found in Table 1. We also estimated both models including country-specific time trends, finding that these were statistically significant in 17 countries in the AMG [1] estimation and in 18 cases in the AMG [2] estimation.…”

“…We also estimated both models including country-specific time trends, finding that these were statistically significant in 17 countries in the AMG [1] estimation and in 18 cases in the AMG [2] estimation. However, since the parameter estimates remained unaltered, we only have considered the results of the AMG estimation without country-specific time trends.…”

“…Finally, it is also possible to find various studies with special reference to the the mediumand long-run effects on output of financial crisis. Regarding the medium-term dynamics of output following banking crisis, Abiad et al (1) consider a sample of 88 banking crisis over the past four decades and across countries with high, middle, and low income levels. The evidence shows that the path of output tends to be substantially and persistently depressed, with no rebound on average to the pre-crisis trend over the medium-run.…”

“…However, it is possible to find many different economic theories that permit different types of long-run non-neutrality at the theoretical level. 1 Two well-known examples are non-superneutrality type models (57,73) and fiscal policy models that allow for long-run effects (9). The former show that short-run monetary factors and portfolio decisions modify the capital stock, output per worker, and the interest rate in the steady state (73); and that a permanent increase in the rate of growth of money raises or lowers long-run output growth -depending on certain structural characteristics of the economy (57).…”

Innovation in the crisis and beyond

“…The fact that downturns specifically related to financial crises can have long-term economic costs has been established in a variety of studies (e.g. Abiad et al, 2009;Cerra and Saxena, 2008;Calvo et al, 2006;Rafferty, 2003). Evolutionary approaches to the economics of innovation following Nelson and Winter (1982) describe the potentially substantial hysteresis effects of shocks (Metcalfe et al, 2006;Dosi et al, 2010).…”