From financial crash to debt crisis

For Carmen Reinhart, the current global financial crisis did not come as much of a surprise.

Reinhart, director of the Center for International Economics at the University of Maryland, gave a talk Tuesday evening at the Yale School of Management on her March 2010 article, “From Financial Crash to Debt Crisis,” co-authored withHarvard economics professor Kenneth S. Rogoff. The article, published in the American Economic Review, details similarities and differences between international financial crises based on historical analysis. The goal of the work wasto discover a cyclical pattern in recessions.

In her talk for the Center for the Study of Globalization, Reinhart presented some of the patterns she found recurringthroughout the financial crises. One of the key conclusions drawn from her work was that private debt surges immediately before banking crises. Reinhart said she defined banking crises as the merging, takeoveror closure of financial institutions by governments or the public sector. She noticed throughout her research that banking crises and surges in public borrowing often accompaniedsovereign debt crises (governments’ failures to fully repay their debts).

“What were private debts before financial crises often become public debts afterwards,” Reinhart said.

Reinhart studied financial crises from a global perspective, looking at aggregate global cycles of debt. After noting changes in the global economy during financial crises, Reinhart and Rogoff compared these patterns with financial data in individual countries. Finally, the researchers checked if these cycles accurately predicted recessions and depressions.

Reinhart and Rogoff studied a variety of economic data such as fluctuations in currency exchange rates, inflation and external debt ratios. Greece, for instance, had an external debt-to-GDP ratio of well over 900 percentin 2009, immediately beforethe current recession. Reinhart said that high external debt ratios often signal financial distress in her research. She said her work highlights that excessive amounts of debt, especially business and consumer debt, can be very harmful to national economies.

“It’s getting hard to ignore debt accumulation,” Reinhart said.

The research examined five international financial crises that occurredafter World War II, all of which followed remarkably similar trends, Reinhart said.

“We have a tendency to believe that financial crises always happen in contexts different from our own,” Reinhart said.“Old rules and lessons learned from the past are thought to no longer apply.”

Yesterday’s talk attracted an audience of roughly 80 people, most of whom were faculty members and SOM students.

“Reinhart was very clear and well-researched,”Ben Gifford ’12 said.

Reinhart and Rogoff also published the book “This Time is Different: Eight Centuries of Financial Folly”in 2009.

Comments