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Digging ourselves out of the current financial crisis will likely take many years, according to a study of similar historical crises around the world.

In an interview with Advisor Perspectives, Carmen M. Reinhart, professor of economics at the School of Public Policy and the Department of Economics at the University of Maryland, who coauthored “The Aftermath of Financial Crises” with Harvard economist Kenneth S. Rogoff, says this crisis won’t be any different. [Ed. Note: We’ve discussed her earlier research in “Carmen Reinhart: Putting the Sub-Prime Crisis in Perspective and the Risks that Remain” and “Will the U.S. Sub-Prime Crisis Be as Bad as History Suggests?”]

According to the Reinhart-Rogoff paper, severe financial crises around the world, including all of the crises since World War II and the crises in Norway in 1899 in the U.S. in 1929, typically share several characteristics:

• “Asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years.”
• “The aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment.”
• “The real value of government debt tends to explode, rising an average of 86 percent in the major post–World War II episodes.”

“A key finding of my work is that crises, especially banking crises, tend to be protracted,” Reinhart said. She believes the U.S. experience will mirror these historical averages, she said, because “the crises that make up those averages were extremely severe crises and we are in an extremely severe crisis.” The increasingly globalized economy of recent years will make recovery more challenging because “it will make it far more difficult for many countries to grow their way out through higher exports, or to smooth the consumption effects through foreign borrowing,” according to her paper.  But U.S. output may not decline as sharply as the averages, she said. That’s because the averages include the sharp declines in output characteristic of crises in emerging markets.

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