VoxEU Column Financial Markets

Global financial crisis: How long? How deep?

The house and equity price busts on top of a credit crunch make this an unprecedented crisis for the modern US economy; its real economy effects are thus difficult to assess. This column provides insights based on evidence from 122 recessions in 21 advanced nations since 1960. Findings suggest recessions in such circumstances are much costlier and slightly longer. But the outcome can be affected by policy, and it’s high time that policymakers act swiftly and decisively.

Although the unprecedented events of the past few weeks in financial markets have dominated the headlines, the debate will inevitably shift to how the most severe financial crisis in modern times impacts the broader economy, and, if recessions in major advanced countries were to occur, how long and how deep these will be. There are already indications that the spillovers from the financial crisis to the broader economy will not be mild—in fact, activity in the US and several other advanced economies has slowed down in recent months.

The unique nature of the current financial crisis - combining a house price bust, a credit crunch, and an equity price bust - unlike any other one the US has experienced before, makes it difficult to assess its implications for the real economy. Barry Eichengreen recently assessed the lessons from the Great Depression (Vox 2008), but what of the evidence from modern times? We have witnessed many such episodes of credit crunches and busts in house and equity prices around the world since 1960. In fact, in recent work, we identified 28 credit crunches, 28 house price busts, 58 equity price busts, and 122 recessions in 21 advanced countries over 1960-2007 (Claessens, Kose and Terrones, 2008). These episodes provide some insights on how financial crises evolve and their implications for the broader economy. 

How to identify economic and financial cycles?

Before analysing recessions and their interactions with credit crunches and asset price busts, it is necessary to determine the dates of these events. The methodology we employ for this purpose focuses on changes in the levels of variables to identify cycles (see Harding and Pagan, 2002). Consistent with the guiding principles of the National Bureau of Economic Research (NBER), which is the unofficial arbiter of US business cycles, this methodology assumes that a recession begins just after the economy climbs a peak of activity and ends as the economy reaches its trough. With the help of this methodology, we identify cycles in output (GDP), and various financial variables, including credit, house prices and equity prices.

How costly are recessions?

As shown in Figure 1, a recession on average lasts about 4 quarters (one year) with substantial variation across episodes — the shortest recession is 2 quarters and the longest 13 quarters. The typical decline in output from peak to trough, the recession’s amplitude, tends to be about 2 percent. For recessions, we also compute a measure of cumulative loss which combines information about both the duration and amplitude to proxy the overall cost of a recession. The cumulative loss of a recession is typically about 3 percent of GDP, but this number varies quite a bit across episodes. We classify a recession as a severe one when the peak-to-trough decline in output is in the top-quartile of all output declines during recessions. These recessions tend to be more than a quarter longer and much more costly than do typical recessions.

Crunches and busts: Often long and painful

The episodes of credit crunches and housing busts are often long and deep (Figure 2). For example, a credit crunch episode typically lasts two and a half years and is associated with nearly a 20 percent decline in real credit. A housing bust tends to last even longer: four and a half years with a 30 percent fall in real house prices. And an equity price bust lasts some 10 quarters and when it is over, the real value of equities has dropped to half.

Are recessions associated with crunches and busts worse than other recessions?

Contrary to the view of some commentators, the triple whammy of a house price bust, a credit crunch and an equity price bust has not always led to an eventual recession. What is true is that many recessions are indeed associated with credit crunches or asset price busts. In about one out of six recessions, there is also a credit crunch underway, and in about one out of four recessions a house price bust. Equity price busts overlap for about one-third of recession episodes. There can also be considerable lags between financial market disturbances and real activity. A recession, if one occurs, can start as late as four to five quarters after the onset of a credit crunch or a housing bust.

One of the key questions surrounding the current financial crisis is whether recessions associated with crunches and busts are worse than other recessions. Here, the international evidence is clear: these types of recessions are not just slightly longer on average, but also have much larger output losses than others. In particular, although recessions accompanied with severe credit crunches or house price busts last only a quarter longer, they have typically result in output losses two to three times greater than recessions without such financial stresses. During recessions coinciding with financial stress, consumption and investment usually register much sharper declines, leading to the more pronounced drops in overall output and unemployment.

Global nature of economic and financial cycles

For some, the global nature of the current crisis has been unprecedented as several advanced economies have simultaneously witnessed declines in house and equity prices as well as difficulties in their credit markets. This is not unusual, however, as recessions, crunches and busts often occur at the same time across countries. Recessions in many advanced countries have been bunched in four periods over the past forty years — the mid-70s, the early 80s, the early 90s and the early-2000s — and have often coincided with global shocks. Moreover, when many countries experience a recession, many also go through episodes of credit contractions, declines in house and equity prices.

What are the lessons for the current episode?

The lessons from the earlier episodes of recessions, crunches and busts are sobering, suggesting that recessions, if they were to occur, would be more costly since they would take place alongside simultaneous credit crunches and asset price busts. Furthermore, although the effects of the current crisis have already been felt gradually around the world, its global dimensions are likely to intensify in the coming months.

The main take-away of the past episodes is that some tough times are ahead for the global economy before matters get better. Nevertheless, the nature of a recession in a particular country, if it happens, would ultimately depend on a number of factors, importantly how healthy the financial positions of its firms, banks, and households are prior to the recession, and what policies are being employed. This is high time for policy-makers to act swiftly and decisively to undertake the necessary measures at both the national and global levels to meet the challenges of the crisis.


Claessens, Stijn, M. Ayhan Kose, and Marco Terrones, 2008, “What Happens During Recessions, Crunches and Busts?” forthcoming IMF Working Paper.

Harding, Don and Adrian Pagan, 2002, “Dissecting the Cycle: A Methodological Investigation,” Journal of Monetary Economics Vol. 49, 365-381.

Figure 1. Recessions: Duration, Amplitude and Cumulative Loss
(duration, amplitude and cumulative loss)

1 Duration refers to the number of quarters between the peak and trough of a recession.
2 Amplitude is the change in GDP between the peak and trough of a recession.
3 Cumulative loss is the total output loss between the peak and trough of a recession.

Figure 2. Crunches and Busts: Duration and Amplitude

1 Duration refers to the number of quarters between the peak and trough of a credit crunch or a house/equity price bust.
2 Amplitude is the change in credit volume or house/equity price between the peak and trough of a credit crunch or a house/equity price bust, respectively.

Source: Claessens, Kose and Terrones (2008).

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