"The Great Contraction of 2008-2009"

Kenneth Rogoff doesn't expect a "sustained sharp" worldwide recovery:

The Great Contraction of 2008-2009, by Kenneth Rogoff, Commentary, Project Syndicate: A popular view among economic forecasters and market bulls is that “the deeper the recession, the quicker the recovery.” They are right – up to a point: immediately after a normal recession, economies do, indeed, often grow much faster than usual... Unfortunately, the Great Recession of 2008-2009 is far from being a normal global recession. The Great Recession was turbo-charged by a financial crisis,... a far more insidious affair that typically has far more long-lasting effects.

As Carmen Reinhart and I argue..., the Great Recession is better described as “The Great Contraction,” given the massive ... contraction of global credit, trade, and growth that the world has experienced. ... [T]he legacy of the huge contraction in credit is not likely to go away anytime soon. ... The optimists say not to worry. Credit will soon come to everyone else as easily as it has to the banks. ...

But this ... fails to recognize the fact that balance sheets remain ... impaired... Housing prices are being propped up temporarily by myriad subsidies, while a commercial real-estate tsunami looms. Many banks’ weaknesses are simply being masked by government guarantees.

Indeed, G-20 governments now face the daunting prospect of trying to rein in the monster they have created. It is now very clear that the taxpayer will always be there to guarantee that bondholders get paid. ... Lenders to banks will not bother worrying about what kinds of gambles ... financial institutions are making, or whether regulation is effective.

The good news is that most governments do see the need to implement significant new regulation on financial firms. But here’s the rub: financial regulation is enormously complicated...[I]f regulators take their time to “get it right,” there will be a huge shadow of uncertainty hanging over the financial system. Banks know that they face higher capital requirements... But how much higher? There is much discussion of breaking up banks that are too big to fail. But what will actually happen?

Given this environment, no wonder credit is still contracting... If banks don’t know what the rules of the game are going to be, they have to be very cautious about over-extending their balance sheets.

So government regulators – and ultimately all of us – are caught... Overly strict regulation could seriously impair global growth for decades. But if regulation is too soft, the next monster global financial crisis could come within a decade. And even if regulators take their time to try to get it right,... the world may have to live with weak credit expansion as banks hold back, awaiting a clearer verdict on their future. ...

I am often asked why economies get themselves into such a bind again and again throughout economic history. Unfortunately,... the answer is all too simple: arrogance and ignorance. Investors and policymakers are often altogether ignorant of the myriad historical experiences with financial crises. And the few that are dimly aware of what has happened in other times and other places all too often say, “Don’t worry, this time is different.”

Perhaps the Great Contraction of 2008-2009 will be different from other deep financial crises, and we will see a sustained sharp recovery worldwide. But G-20 policymakers are best advised not to bet on it...

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