What Happens During Recessions, Crunches and Busts? Stijn Claessens, M. Ayhan Köse K and Marco E. Terrones Financial Studies Division Research Department International Monetary Fund 1
Disclaimer! The views presented here are those of the authors and do NOT necessarily reflect the views of the IMF or IMF policy 2
Motivation In some advanced countries, especially the United States Sharp decline in house/equity prices; tightening credit Slowdown in economic activity Concerns about recession: duration and amplitude But, generally, relationships between credit, asset price movements, and economic activity in recessions not well understood 3
Motivation What do we know about recessions, as they relate to credit (crunches) and asset prices (busts)?? So far only a small sample of (case) studies have been studied. asset-price price-bust recessions do not appear to be necessarily more costly than other recession episodes. Specifically,,, recessions that follow swings in asset prices are not necessarily longer, deeper, and associated with a greater fall in output and investment than other recessions Roger W. Ferguson, January 12, 2005 Ferguson was the Vice Chairman of the FRB over 1997-2006 4
Objective: Three Questions How do macro and financial variables behave around recessions, crunches and busts? Are recessions associated with credit crunches and asset price busts different than other recessions? What might this mean for recent developments in the United States? How? By providing a comprehensive analysis of a large number of recessions, crunches and busts (purely statistical exercise; event study; no discussion of causation or potential sources) 5
Results How do macro and financial variables behave around recessions, crunches and busts? Mostly procyclical. Residential investment and credit appear to be the key variables to understand the direction of the economy (especially in the United States) Are recessions associated with credit crunches and asset price busts different than other recessions? Yes. Recessions associated with crunches and busts tend to be longer and deeper What might this mean for recent developments in the US? Signs of a slowing economy but also an aggressive monetary policy stance already in place. Not clear whether this will be a mid-cycle slowdown or recession 6
Outline Data and Methodology Recessions: Basic Characteristics Credit Crunches and Asset Price Busts Recessions, Crunches and Busts Policy Responses Recent Developments in US Conclusions 7
Database Country Sample: : 21 OECD countries; Quarterly data; 1960:1-2007:4; OECD, BIS, HAVER, IFS Macro Variables: Output, consumption, investment, industrial production, unemployment, inflation, exports, and imports Financial Variables: Credit, house and equity prices Policy Variables: Government consumption and short-term term interest rates 8
Countries Included in Study Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, the United Kingdom, and the United States 9
Evolution of a Business Cycle Aggregate economic activity Linear growth path Expansion Recession Expansion Trough Peak Time Trough Peak 10
Methodology Find cyclical turning points in macro and financial variables using standard business cycle dating algorithm (Harding and Pagan, 2002, Journal of Monetary Economics) Document chronologies of business cycles using a consistent definition; similar to the NBER turning points in the United States Examine the basic characteristics (duration, amplitude) and temporal patterns around recessions; analyze the macroeconomic variables in recessions coinciding with credit crunches and asset price busts 11
Methodology Identify severe recessions, credit crunches and asset price busts Severe Recession: a peak-to to-trough trough decline in GDP in the worst quartile of all declines Credit Crunch: a peak-to to-trough trough contraction in credit in the worst quartile of all credit contractions Asset Price Bust: a peak-to to-trough trough decline in asset prices in the worst quartile of all price declines 12
Macro Recessions and Financial Contractions Is the sample large enough? Yes Macro Recessions -122 Recessions in GDP (30 Severe), US (7/0) Financial Contractions - 112 Contractions in Credit (28 Crunch), US (5/2) - 114 Declines in House Prices (28 Busts), US (7/0) - 234 Declines in Equity Prices (58 Busts), US (14/1) 13
Recessions in OECD (fraction of countries in recession; shaded bars are US recessions) 60 50 40 GDP 30 20 10 0 1960Q1 1963Q1 1966Q1 1969Q1 1972Q1 1975Q1 1978Q1 1981Q1 1984Q1 1987Q1 1990Q1 1993Q1 1996Q1 1999Q1 2002Q1 2005Q1 14
Recessions and Credit Contractions (fraction of countries, shaded bars are US recessions) 60 GDP 40 Credit 20 0 1960Q1 1963Q1 1966Q1 1969Q1 1972Q1 1975Q1 1978Q1 1981Q1 1984Q1 1987Q1 1990Q1 1993Q1 1996Q1 1999Q1 2002Q1 2005Q1 15
Recessions and House Price Contractions (fraction of countries; shaded bars are US recessions) 80 House Prices 60 40 20 GDP 0 1970Q1 1973Q1 1976Q1 1979Q1 1982Q1 1985Q1 1988Q1 1991Q1 1994Q1 1997Q1 2000Q1 2003Q1 2006Q1 16
Recessions and Equity Price Contractions 100 (fraction of countries, shaded bars are US recessions) 80 Equity Prices 60 40 20 GDP 0 1960Q1 1963Q1 1966Q1 1969Q1 1972Q1 1975Q1 1978Q1 1981Q1 1984Q1 1987Q1 1990Q1 1993Q1 1996Q1 1999Q1 2002Q1 2005Q1 17
What did we learn? Recessions coincide to some degree across OECD countries Recessions have been fewer as business cycles have moderated over time Credit contractions overlap most often with recessions House price declines overlap quite often with recessions Equity price declines are more independent from output recessions ( predict( 8 out of 5 recessions ) 18
Outline Data and Methodology Recessions: Basic Characteristics Credit Crunches and Asset Price Busts Recessions, Crunches and Busts Policy Responses Recent Developments in US Conclusions 19
Recessions: Duration (# of quarters from Peak to Trough) 5 4 3 2 1 All Recessions Severe Recessions 20
Recessions: Amplitude ( percent change in GDP from Peak to Trough) 0.0-1.0-2.0-3.0-4.0-5.0-6.0 All Recessions Severe Recessions 21
Recessions: Macroeconomic Variables 0 (percent change from Peak to Trough) -2-4 -6-8 -10 All Recessions -12 Severe Recessions -14 Output Consumption Res Investment Non-Res Investment Total Investment Industrial Production 22
Recessions: Unemployment Rate and Inflation 2 (percentage point change from Peak to Trough) 1 All Recessions Severe Recessions 0-1 Unemployment Rate Inflation Rate 23
Typical Recession Dynamics Compare the evolution over 12 quarters before and after peak of economic and financial data with the medians of past recessions in the United States and other OECD countries Percent changes from a year earlier; zero denotes the peak, or the beginning of a recession Shaded areas are upper and lower quartiles of past recessions in other OECD countries 24
Recessions: GDP (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 6 GDP 4.5 US 3 1.5 OECD-US 0-1.5-3 -12-8 -4 0 4 8 12 25
8 6 4 2 Recessions: Industrial Production (Percent change from a year earlier; zero denotes peak; x-axis x quarter) Industrial Production US OECD-US 0-2 -4-6 -12-8 -4 0 4 8 12 26
Recessions: Residential Investment (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 15 10 Residential Investment 5 OECD-US 0-5 -10-15 US -20-12 -8-4 0 4 8 12 27
Recessions: Private Credit (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 12 Private Credit 9 6 3 OECD-US 0-3 -12-8 -4 0 4 8 12 US 28
Recessions: House Prices (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 12 House Price 8 4 OECD-US 0 US -4-8 -12-8 -4 0 4 8 12 29
30 Recessions: Equity Prices (Percent change from a year earlier; zero denotes peak; x-axis x quarter) Equity Price 20 10 US 0 OECD-US -10-20 -30-12 -8-4 0 4 8 12 30
What did we learn? Most macro variables are procyclical during recessions in the US and other OECD countries Credit, house prices and equity prices start weakening ahead of recessions Recessions in the United States vs. other OECD countries - Similarities: Duration and amplitude of output - Differences: Typically, deeper contractions in industrial production, residential investment and credit in the US than in other OECD countries 31
Outline Data and Methodology Recessions: Basic Characteristics Credit Crunches and Asset Price Busts Recessions, Crunches and Busts Policy Responses Recent Developments in US Conclusions 32
Crunches and Busts: Duration (# of quarters from Peak to Through) 20 15 10 5 0 Credit Crunch House Price Bust Equity Price Bust 33
Crunches and Busts: Amplitude (percent change from Peak to Trough) 0-15 -30-45 -60 Credit Crunch House Price Bust Equity Price Bust 34
Crunches and Busts: Investment (percent change from Peak to Trough) 5 0-5 -10 Residential Investment Total Investment -15 Credit Crunch House Price Bust Equity Price Bust 35
What did we learn? Credit crunches and asset price busts can last a long time, typically longer than output recessions Credit crunches and asset busts are associated with substantial declines in credit and asset prices While output can recover during a credit crunch or housing bust, (residential) investment drops significantly 36
Outline Data and Methodology Recessions: Basic Characteristics Recessions: Macro Variables Recessions, Crunches and Busts Policy Responses Recent Developments in US Conclusions 37
Recessions, Crunches and Busts Identify recessions coinciding with credit crunches and asset price busts (a crunch or bust starting before or occurring at the same time) - 18 Recessions overlap with Credit Crunches - 34 Recessions overlap with House Price Busts - 45 Recessions overlap with Equity Price Busts Study duration and amplitude of these events; Focus on certain macroeconomic variables 38
Recessions w/ Crunches and Busts: Duration (# of quarters from Peak to Trough) 5 4 * * Recession without Recession with Recession with Severe 3 2 1 0 Credit Crunch House Price Bust Equity Price Bust 39
0.0 Recessions w/ Crunches and Busts: GDP (percent change from Peak to Trough) -0.5-1.0-1.5-2.0-2.5-3.0 * * Recession without Recession with Recession with Severe Credit Crunch House Price Bust Equity Price Bust 40
Recs w/ Crunches and Busts: Residential Investment 0-1 -2-3 -4-5 (percent change from Peak to Trough) -6-7 -8 * * Recession without Recession with Recession with Severe -9 Credit Crunch House Price Bust Equity Price Bust 41
Recessions w/ Crunches and Busts: Unemployment (percentage point change from Peak to Trough) 1.5 Recession without Bust Recession with Bust Recession with Severe Bust * * 1.0 0.5 0.0 Credit Crunch House Price Bust Equity Price Bust 42
Recessions w/ Crunches and Busts: Inflation (percentage point change from Peak to Trough) 1.0 0.5 Recession without Bust Recession with Bust Recession with Severe Bust 0.0-0.5-1.0 Credit Crunch House Price Bust Equity Price Bust 43
What did we learn? Are recessions associated with credit crunches and house price busts different than other recessions in OECD countries? Yes. Recessions with credit crunches and housing price busts are on average associated with slightly longer and deeper recessions, with greater declines in residential investment and higher unemployment 44
Outline Data and Methodology Recessions: Basic Characteristics Credit Crunches and Asset Price Busts Recessions, Crunches and Busts Policy Responses Recent Developments in US Conclusions 45
Recessions w/ Crunches and Busts: Interest Rates 0.0 (short-term term real rates; percentage point change from Peak to Trough) -0.5 ALL -1.0 SEVERE without bust with bust -1.5 Recessions Credit Crunches House Price Busts Equity Price Busts 46
4.0 Recessions w/ Crunches and Busts: Gov Cons (percent change from Peak to Trough) 3.0 without bust with bust 2.0 ALL SEVERE 1.0 0.0 Recessions Credit Crunches House Price Busts Equity Price Busts 47
What did we learn? Policy -related variables differ by severity of and type of recessions In severe recessions, observe lower real interest rate and higher government consumption In recessions with credit crunches, government consumption increases much more than in other recessions 48
Outline Data and Methodology Recessions: Basic Characteristics Credit Crunches and Asset Price Busts Recessions, Crunches and Busts Policy Responses Current Slowdown in US Conclusions 49
Current Slowdown in US Compare the evolution over past three years in US economic and financial data with the medians of past recessions in the United States and other OECD countries Shaded areas are upper and lower quartiles of past recessions in other OECD countries For presentational purposes,, the last available observation, 2008 first quarter, is assumed to be the peak of the current US business cycle 50
GDP Growth Somewhat Below Typical (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 6 GDP 4.5 US 3 1.5 US current OECD-US 0-1.5-3 -12-8 -4 0 4 8 12 51
Consumption on Typical Path (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 6 Consumption 4 US 2 US current OECD-US 0-2 -12-8 -4 0 4 8 12 52
Ind l Prod Somewhat Below Typical (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 8 6 Industrial Production US 4 2 0 US current OECD-US -2-4 -6-12 -8-4 0 4 8 12 53
Total Investment Down Steeper (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 12 Total Investment 8 US 4 0 OECD-US -4 US current -8-12 -12-8 -4 0 4 8 12 54
Res l Investment Down More Sharply (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 15 10 5 Residential Investment US 0-5 OECD-US -10-15 US current -20-25 -12-8 -4 0 4 8 12 55
Non Res Investment Staying Up (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 12 10 8 Nonresidential Investment US current 6 4 US 2 0 OECD-US -2-4 -6-8 -10-12 -8-4 0 4 8 12 56
Exports Growing Above Typical (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 15 Exports 10 US current OECD-US 5 US 0-5 -12-8 -4 0 4 8 12 57
Imports on Typical Slowdown Path (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 15 Imports 10 US 5 OECD-US 0 US current -5-10 -12-8 -4 0 4 8 12 58
Inflation Going Up from Below Typical 15 Inflation Rate (Percent; zero denotes peak; x-axis x quarter) 10 OECD-US 5 US US current 0-12 -8-4 0 4 8 12 59
10 Unemployment on Typical Path (Percent; zero denotes peak; x-axis x quarter) Unemployment Rate 8 6 US OECD-US 4 US current 2-12 -8-4 0 4 8 12 60
Credit, after Growth, on Downward Path (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 12 Private Credit US current 8 4 OECD-US 0 US -4-12 -8-4 0 4 8 12 61
House Prices Growth Down Sharply (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 12 10 House Price 8 6 US current 4 2 0 OECD-US US -2-4 -6-8 -12-8 -4 0 4 8 12 62
Equity Prices Increase, after Up, Down (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 30 Equity Price 20 10 US current US 0-10 OECD-US -20-30 -12-8 -4 0 4 8 12 63
Short-term term Interest Rates Down Sharply (Percent change from a year earlier; zero denotes peak; x-axis x quarter) 6 Real Short-term Interest Rate 4 US current 2 OECD-US 0 US -2-12 -8-4 0 4 8 12 64
Gov Consumption on Upward Path (Percent; zero denotes peak; x-axis x quarter) 6 Government Consumption 5 4 3 OECD-US 2 US 1 US current 0-12 -8-4 0 4 8 12 65
What did we learn? Signs of a slowing economy The declines in house prices and residential investment in the current episode are sharper than those observed in earlier recessions Yet, the monetary policy response appears to be more aggressive relative to earlier episodes Not clear whether this will be a mid-cycle slowdown or recession 66
Outline Data and Methodology Recessions: Basic Characteristics Credit Crunches and Asset Price Busts Recessions, Crunches and Busts Policy Responses Recent Developments in US Conclusions 67
Conclusions How do macro and financial variables behave around recessions, crunches and busts? Mostly procyclical. Residential investment and credit appear to be the key variables to understand the direction of the economy (especially in the United States) Are recessions associated with credit crunches and asset price busts b different than other recessions? Yes. Recessions associated with crunches and busts tend to be longer and deeper What might this mean for recent developments in the US? Signs of a slowing economy but also an aggressive monetary policy stance already in place. Not clear whether this will be a mid-cycle slowdown or recession 68
Some Caveats No causal inferences made or intended as to how financial variables affect macroeconomic outcomes Initial conditions and policy responses affect the path economy follows External conditions, demand and supply shocks matter as well Business cycles have moderated over time 69
Future research can focus on Future Research Alternative metrics of economic activity (output gap) Different pattern in financial stress/crisis episodes Interactions with global business cycles and emerging market cycles Micro/corporate behavior around recessions/busts 70
Questions & Comments Thank you! M. Ayhan Kose akose@imf.org 71