Financial Crises: A Close-up

In our issue of May 7, we wrote about the IMF’s  study of 122 recessions in 21 “advanced” countries since 1960. They found that downturns associated with financial crises are far longer and deeper, and recoveries slower and weaker, than those that aren’t financially driven. Here’s a close-up of the behavior of interest rates, stock prices, inflation, and employment in the four years after the onset of the crisis in 15 major financially driven recessions identified by the IMF. (See notes below)

In a nutshell, we found that on average, interest rates and inflation generally decline for the full four years; stock prices rise steadily, though not explosively, after a two-quarter decline; and employment falls for about three years before beginning a weak recovery.

GDP experiences are quite varied, with some countries experiencing sharp, sustained declines; others, brief, sharp declines followed by a strong recovery; and still others, extended periods of stagnation. Those disparate experiences produced a very misleading “average” line, so we are not providing a GDP graph. But despite those contrasting GDP patterns, almost all countries suffered from a very weak job market for several years after the financial system hit a wall.

GDP Employment
Australia -1.7% -3.8%
Denmark -8.7
Finland -20.5 -19.2
France -1.0 -1.5
Germany -2.8 -3.1
Greece -1.6
Italy -2.2 -8.2
Japan 1 -3.9 -0.4
Japan 2 -3.4 -2.3
New Zealand -7.6 -6.9
Norway -7.9 -6.6
Spain -0.4 -9.0
Sweden -18.5 -13.1
UK 1 -3.4 -1.2
UK 2 -2.5 -6.2
average -5.8 -6.3
median -3.4 -6.2
Total decline in real GDP and total employment in recessions in the IMF sample, from pre-crisis maximum to cycle low

Comparing recent U.S. experience to the average yields the following conclusions. Interest rates, inflation, and stock prices are all down much harder than the “typical” experience. This suggests that interest rates are probably not at risk of rising sharply, but we’re almost certainly past their bottom; stock prices, even with the recent rally, are not acting with outlandish exuberance; and inflation isn’t much of a risk for some time to come. Employment, however, is tracking the average very closely, suggesting that while the worst of the job losses are probably behind us, we’ve got another year and a couple of million to go.

Interest rates: down
Although financial crises typically come with a huge fiscal cost, as revenues sag and bailout expenditures rise, interest rates on long government bonds tend to decline steadily throughout the four year period we studied. Rates fell in 12 of the 15 examples over the first 8 quarters following the crisis, and 13 of 15 over 16 quarters.

Stocks: mostly up
Stock prices do surprisingly well in financial crises, after an initial spill. Actually, prices tend to decline over the year leading up to the crisis (about 4–5% on average); the post-crisis leg down is sharper but shorter than what preceded it (about 12%). But after that decline, stock prices tend to rise, though at far from a barn-burning pace—only around 5% a year.

Inflation: down
Though a lot of market participants expect that the financial bailout will ultimately prove inflationary, the history of financial crises suggests otherwise.

Employment: down hard
Deep, sustained declines in employment are almost universal following financial crises. If these averages hold, we’re about two-thirds of the way through the contraction in numbers, and not quite that far in time.


In the four graphs, the line labeled “average” is the mean of the 15 financially driven recessions identified by the IMF, with the quarter of the crisis’ onset set to 100. The line labeled “U.S.” is the recent experience of the United States, with the onset of crisis set to the third quarter of 2007. Horizontal axis represents quarters before and after crisis onset (“C”).

These are the crises the IMF reviewed:

Australia 1990Q2–1991Q2
Denmark 1987Q1–1988Q2
Finland 1990Q2–1993Q2
France 1992Q2–1993Q3
Germany 1980Q2–1980Q4
Greece 1992Q2–1993Q1
Italy 1992Q2–1993Q3
Japan 1993Q2–1993Q4
Japan 1997Q2–1999Q1
New Zealand 1986Q4–1987Q4
Norway 1988Q2–1988Q4
Spain 1978Q3–1979Q1
Sweden 1990Q2–1993Q1
United Kingdom 1973Q3–1974Q1
United Kingdom 1990Q3–1991Q3