Next month marks the tenth anniversary of the failure of Lehman Brothers – the nadir of the 2008 global financial crisis. Not only was there a substantial fall in GDP in most countries (although not in Australia), but the recovery since then has been slow. GDP just about everywhere is well below the pre-crisis expected trend-line growth path. 

Just why this is so is a matter of debate, but researchers at the Federal Reserve Bank of San Francisco (FRBSF) have offered an estimate that without the abnormal severity of the 2008 crisis, American GDP would be 7% higher than it is. Ouch!

Economic theory suggests that recoveries after recessions would be “V”-shaped, with the economy returning promptly to the pre-recession growth trend line. Earlier articles (Rethinking macro-economics: fiscal policy) have noted that this recovery has been quite different for the crisis-affected economies: actual income is way below the pre-crisis trend: these FRBSF estimates suggest 12%. 

Was the pre-crisis trend overly optimistic; or did the crisis permanently reduce productive capacity and growth potential; or were post-crisis policies responsible for the outcome?

It’s not possible to re-run history, so we can’t know. The answer may be “all of the above”. Researchers at the FRBSF have modelled one plausible hypothesis. They argue that financial conditions exert an asymmetric effect on the economy: while tight financial conditions can constrain economic activity, looser financial conditions (i.e. the situation since 2008) don’t necessarily stimulate activity. You can take a business opportunity to water, but you can’t make it drink.

Their counter-factual simulations suggest that, if the 2008 downturn had been more like the 1991 recession (i.e. without the big financial disruption), the path of GDP would have looked like this. 

American GDP would have been 7% higher than it is. This represents a permanent and ongoing year-after-year loss of income. As the crisis also worsened income distribution, poor Americans are even worse off than this aggregate figure implies.

This simulation adds weight to the argument, made often enough (The elusive confidence fairy), that the accommodative monetary policy implemented after 2008 wasn’t enough, in itself. The fiscal austerity imposed in the 2010-2014 period was inappropriate. 

This study attempts to put a number on the ongoing cost of the crisis. It would be easy to disagree with the exact modelling, but it’s hard to deny the broad message: this was an enormously costly episode of misguided policies before and after 2008, and not just in America.