Fiscal Consequences Of Financial Crises

Fiscal Consequences of Financial Crises Carmen M. Reinhart, University of Maryland, NBER Schwartz Economic Symposium, September 15, 2009 based on:

This Time is Different: Eight Centuries of Financial Folly with Kenneth S. Rogoff (Princeton University Press, 2009)

As to the fiscal aftermath of banking crises, we find: 

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That the nearly universal focus on calculations of bailout costs as the centerpiece of the fiscal consequences of banking crises is misguided and incomplete. Banking crises weaken fiscal positions beyond the costs of bailouts, as government revenues contract and stimulus plans find favor. Reinhart and Rogoff

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Financial crises are historically associated with the “deadly D’s” 

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Sharp economic downturns follow banking crises; with government revenues shrinking, fiscal deficits worsen; deficits lead to debt; as debt piles up rating downgrades follow. For the most fortunate countries, the crisis does not lead to the deadliest D: default, but for many it has. Reinhart and Rogoff

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On the first point, the discrepancies across estimates of bail-out costs are large and in, some cases, staggering

Reinhart and Rogoff

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Fiscal deficits as a percent of GDP

Country (crisis year)

Argentina, 2001 Chile, 1980

Reinhart and Rogoff

Year b

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On the second point, government revenues suffer as the crisis lingers Real Governm ent ReveuesandBankingCrises (annual percent changes) 5 4 3

Percent

2 1 0 t-3

t-2

t-1

T

t+1

t+2

t+3

-1

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Thus, the true legacy of financial crises is more government debt… Cumulativeincreasein public debt in thethreeyears following thebankingcrisis Malasia Mexico Japan Norway Philippines Korea Sweden Thailand Average Spain Indonesia Chile Finland Colombia

Index=100in year of crisis

Averageis186.3

Reinhart and Rogoff

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Institutional Investor sovereign r Peak-to-trough index declines (l

Reinhart and Rogoff

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Policy issues going forward 

Soaring debt: Policy makers should be concerned about the debt levels (explicit and implicit) that it is likely to take on as it works its way out of the crisis

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Financial crises are “hardy perennials”-- regulation needs to be constantly revised and revisited to “keep up” with market innovation.

Reinhart and Rogoff

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