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Slow Recovery: Bad Policy or the Norm Following a Financial Crisis

May 4, 2013

Reinhart-Rogoff Revisited The recent release of GDP data continues to show a weak recovery which many who contribute here have attributed regime uncertainty and inappropriate policy. The Wall Street Journal (“A Jobs Fillip”) comes to a similar conclusion: Left to its own devices, the U.S. economy will grow as individuals and businesses try to improve their lot and expand. The tragedy of the last four years is that Washington tried to supplant or interfere with those decisions with a wave of regulation, spending and taxation. John B. Taylor also sees the slow recovery as caused by “ineffective policy interventions” in this comment on the data (“Another Take on Reinhart-Rogoff Controversy”) :

The updated charts below incorporate last Friday’s release of the first quarter GDP data. They continue to tell the story of a weak recovery which, in my view, is largely due to ineffective government policy interventions. There is, of course, an alternative view: that the recovery is weak because the recession and the financial crisis were severe.

This view takes the onus off bad policy as the cause of the slow recovery and bolsters the argument (erroneous in my view) that without stimulus things would have been worse. This alternative view is based on empirical work by Reinhart-Rogoff (This Time Is Different). Reinhart and Rogoff have been in the news recently because of errors in their empirical work on the impact on economic growth from large debt/GDP ratios (see here and here).

This error has received lots of press lately, as Taylor points out, because the correction of the error provides data that can be used to “support more fiscal stimulus and less consolidation.” Michael Bordo has provided strong evidence that Reinhart-Rogoff were also mistaken in their empirical research in This Time Is Different. U. S. data does not support the Reinhart-Rogoff conclusion that that slow recovery following a financial crisis is the norm. Despite the fact that “Bordo wrote about his findings (which are based on his joint research with Joe Haubrich of the Cleveland Fed) in a September 27, 2012 Wall Street Journal article, ‘Financial Recessions Don't Lead to Weak Recoveries’”, this error has received minimal coverage in the press and the blogosphere especially compared to mountains of positive press of covering the exposure of errors in their work on debt and growth. Bordo’s correction is, as Taylor speculates, largely ignored because it lends support to the bad policy–slow recovery causal link.

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