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Sovereigns Versus Banks: Credit, Crises and Consequences

43 Pages Posted: 27 Mar 2015  

Oscar Jorda

Federal Reserve Banks - Federal Reserve Bank of San Francisco; University of California, Davis

Moritz Schularick

University of Bonn - Department of Economics; Centre for Economic Policy Research (CEPR)

Alan M. Taylor

University of California, Davis - Department of Economics; University of Virginia - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: October 2013

Abstract

Two separate narratives have emerged in the wake of the Global Financial Crisis. One interpretation speaks of private financial excess and the key role of the banking system in leveraging and deleveraging the economy. The other emphasizes the public sector balance sheet over the private and worries about the risks of lax fiscal policies. However, the two may interact in important and understudied ways. This paper examines the co-evolution of public and private sector debt in advanced countries since 1870. We find that in advanced economies significant financial stability risks have mostly come from private sector credit booms rather than from the expansion of public debt. However, we find evidence that high levels of public debt have tended to exacerbate the effects of private sector deleveraging after crises, leading to more prolonged periods of economic depression. We uncover three key facts based on our analysis of around 150 recessions and recoveries since 1870: (i) in a normal recession and recovery real GDP per capita falls by 1.5 percent and takes only 2 years to regain its previous peak, but in a financial crisis recession the drop is typically 5 percent and it takes over 5 years to regain the previous peak; (ii) the output drop is even worse and recovery even slower when the crisis is preceded by a credit boom; and (iii) the path of recovery is worse still when a credit-fueled crisis coincides with elevated public debt levels. Recent experience in the advanced economies provides a useful out- of-sample comparison, and meshes closely with these historical patterns. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now.

JEL Classification: C14, C52, E51, F32, F42, N10, N20

Suggested Citation

Jorda, Oscar and Schularick, Moritz and Taylor, Alan M., Sovereigns Versus Banks: Credit, Crises and Consequences (October 2013). Institute for New Economic Thinking Working Paper Series No. 3. Available at SSRN: https://ssrn.com/abstract=2585696 or http://dx.doi.org/10.2139/ssrn.2585696

Oscar Jorda

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

University of California, Davis

One Shields Avenue
Davis, CA 95616
United States

Moritz Schularick

University of Bonn - Department of Economics ( email )

Bonn
Germany

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Alan M. Taylor (Contact Author)

University of California, Davis - Department of Economics ( email )

One Shields Drive
Davis, CA 95616-8578
United States
530-752-1572 (Phone)
530-752-9382 (Fax)

HOME PAGE: http://www.econ.ucdavis.edu/faculty/amtaylor/

University of Virginia - Department of Economics ( email )

P.O. Box 400182
Charlottesville, VA 22904-4182
United States
(434)-924-3177 (Phone)
(434)-982-2904 (Fax)

HOME PAGE: http://people.virginia.edu/~amt7u

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://nber.org

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

HOME PAGE: http://cepr.org

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