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Study Suggests Recovery in U.S. Is Relatively Vital

Harvard economists Kenneth Rogoff and Carmen Reinhart in Reinhart's home in Washington in 2010.
Mary F. Calvert | The New York Times
Harvard economists Kenneth Rogoff and Carmen Reinhart in Reinhart's home in Washington in 2010.

PHILADELPHIA — Academic heavyweights have been debating whether the current United States economy is so sluggish because of too much government stimulus or not enough, or because slower growth had become the norm even before the recession.

But maybe these arguments share a faulty premise.

The American economy is actually doing reasonably well — at least compared with what would be expected after a major financial crisis — according to a provocative study from Carmen M. Reinhart and Kenneth S. Rogoff, Harvard economists and financial crisis historians whose work has been attacked and embraced by the political right and left.

The study, presented over the weekend at the annual meetings of the American Economic Association, rejects comparisons with regular postwar American recoveries, as other economists have made, and instead examines 100 major, or "systemic," financial crises that have occurred over the last two centuries, in the United States and abroad.

(Read more: Here's why the Fed's QE program has 'no effect')

It found that relative to previous American financial crises, the current economy is doing substantially better. Across nine major financial crises in the United States, the average peak-to-trough decline in inflation-adjusted per-capita gross domestic product is about 9 percent, and it has taken an average of 6.7 years to recover to the precrisis peak. During the years after crises, five of the nine episodes also had a "double-dip" downturn.

By contrast, the recent American subprime crisis beginning in 2007 had "only" a 5 percent drop in per capita output, and took "only" six years to get back to the precrisis peak. And so far, at least, there has been no second downward turn.

Employment and other measurements currently remain well below their precrisis peaks, but it is difficult to compare those numbers to past crises because the historical data for those categories is not as reliable, Ms. Reinhart said. Relative to its current peer countries, the study says, the United States is also doing unusually well.

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Eleven other countries experienced systemic crises around the time theUnited States did: France, Germany, Greece, Iceland, Ireland, Italy, the Netherlands, Portugal, Spain, Ukraine and Britain. Six years later, just two of them—the United States and Germany—have recovered to their previous peak in real income.

While the United States has been doing well relative to historical crises, the other advanced countries seem to be doing especially poorly compared with their performance after previous crises.

"This crisis may in the end surpass in severity the Great Depression in a large number of countries," Ms. Reinhart said in an interview. "In fact, it may very well have one of the most protracted and painful recoveries for advanced countries in the aggregate."

Historical data shows that it takes about 7.4 years for the average advanced country that experienced a major crisis to reach its prior peak in real per-capita income; with nearly seven years gone by since the 2007 crisis began, many advanced countries still appear to be contracting.

Ms. Reinhart offered a few explanations for why the study showed the United States doing unusually well compared with both its past self and its current peers, however bad it still feels to the typical American worker. Among the biggest likely contributors are the major monetary and fiscal stimulus measures American policy makers undertook early in the crisis, which helped limit losses from the recession.

The United States also had some effective restructuring of debt through foreclosures. In some states, when the house is seized, borrowers do not usually still owe the balance of the loan. In much of Europe, Ms. Reinhart said, "You lose your house, but not the debt."

Finally, and perhaps most significant, the United States was still able to borrow money easily as the rest of the world sought safe assets. These enthusiastic lenders allowed American politicians to avoid the truly crippling austerity measures that countries like Greece resorted to in order to try to pay their bills.

(Read more: Six years post recession, a tale of two Americas)

"Why would any politician in their right mind undertake the kinds of austerity measures Greece has done? Because no one will lend to them, and existing creditors want full repayment," Ms. Reinhart said. "When the rest of the world is unwilling to lend, you do things that are driven by necessity."

Ms. Reinhart said one of the policy implications of the new study was that Europe needed to engage in substantially more restructuring, both of public and private debt.

While an earlier, much debated paper that she wrote with Mr. Rogoff about the correlation between high debt and lower growth was cited by congressional Republicans to justify austerity measures, she said her work over all had instead emphasized debt restructuring as a useful policy response.

"If you're going to engage in austerity, your best shot is if you at least couple it with something else, like debt write-offs, or inflation," she said. "But they're all ugly scenarios, really."

Asked about the debate on whether some underlying "secular stagnation" might have also predated the subprime crisis, as Lawrence H. Summers, her Harvard colleague and a former Obama administration official, has been arguing, she said it was too soon to tell. But she said the long-term decline in labor force participation was worrisome.

In a talk at the weekend conference, Mr. Summers reiterated his concerns about slow growth that in his view began before the crisis and that he had previously discussed in a speech in November at the International Monetary Fund.

These doldrums, he said on Saturday, stem from factors including slower population growth, a possible decline in technology innovation and changes in the distribution of income — not only between the rich and poor but also between corporations and households.

With interest rates already so low, he said, it is difficult to use expansionary monetary policy to encourage investment. Instead, he called for government spending, particularly on infrastructure, especially while government borrowing costs are so cheap.

(Read more: 1930s-style debt defaults likely, says IMF research)

"The central imperative is anti-austerity, not austerity," he said, "and it has the potential to be as free a lunch as economics will ever find."

If Mr. Summers's theory is accurate, said John B. Taylor, a Stanford economist who served in Republican presidential administrations, "You would have expected the economy to not have been working so well before the crisis. He says it wasn't. I say it was."

Mr. Taylor said that such measures as inflation, housing investment and unemployment showed a strong economy leading up to the crisis.

Unlike the Reinhart-Rogoff work, Mr. Taylor argues that it is fair to compare some postwar recoveries to the current one—a comparison that does indeed make today's economic conditions look unusually bad.

He places blame for this tepid recovery on economic uncertainty and regulation, and on what he calls a departure from rules-based, predictable monetary policy.

—By Catherine Rampell and Shaila Dewan, The New York Times

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