What makes this recovery different is that it follows a recession brought on by a financial crisis. A growing body of research has found that such recoveries tend to be slower than those after “normal” recessions. Prakash Kannan, an economist at the IMF, examined 83 recessions in 21 rich countries since 1970. In the first two years after normal recessions growth averaged 3.7%. After the 13 caused by crises, growth averaged 2.4%. America has been doing slightly better than this (see chart 1).
The Federal Reserve brought on most post-war recessions by raising interest rates to squeeze out inflation. When the Fed cut rates, demand revived. Financial crises interfere with the transmission of lower rates to private borrowers. People can’t or won’t borrow because the value of their collateral—in particular, houses—has fallen. Banks are less able to lend because their capital has been depleted by bad loans, or less willing because customers can’t meet tighter underwriting standards.
The great debt drag, The Economist
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