Credit, the Recession’s Culprit

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The more leveraged they come, the harder they fall. A new analysis from the Federal Reserve of San Francisco argues that the severity of the recession and the uneven pace of recovery has more to do with the amount of credit accumulated pre-recession over other factors.

The paper, by Fed researcher Oscar Jorda, points out that the higher a country’s ratios of private lending to GDP, and the larger its financial sector, the slower employment and investment have recovered. Jorda looked at 140 years of data in 14 advanced economies and concluded:

"Countries that experienced the largest credit booms, such as the United Kingdom, Spain, the Baltic States, Ireland, and the United States, are experiencing the slowest recoveries. Economies that entered the recession with comparatively low leverage, such as Germany, Switzerland, and emerging market countries, have emerged from the downturn quickly."

Jorda also notes that since World War II, no other recessions have involved such a widespread collapse of the financial sector and wiped out so much bank lending capital.  In fact, a year into the housing bust, the economic indicators all closely mirrored models of earlier recessions — until the collapse of Lehman Brothers. Then things really went haywire. Accordingly, Jorda recommends that forecasters lower their U.S. growth prospects for 2012 and 2013 by as much as .8 of a percentage point — a significant number given the Federal Reserve forecasts only 2 to 3 percent real GDP growth for 2012 and 2013.  Don’t take your money out from under that mattress just yet.

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