The Great Recession’s long-term damage
Laurence Ball 01 July 2014
Whereas textbook macroeconomic theory suggests that output should return to potential after a recession, there is mounting evidence that deep recessions have highly persistent effects on output. This column reports estimates of the long-term damage caused by the Great Recession. In most countries in the sample, the loss of potential output – 8.4% on average – has been almost as large as the loss of actual output. In the countries hit hardest by the recession, the growth rate of potential output is much lower today than it was before 2008.
According to macroeconomics textbooks, a fall in aggregate demand causes a recession in which output drops below potential output – the normal level of production given the economy’s resources and technology. This effect is temporary, however. A recession is followed by a recovery period in which output returns to potential, and potential itself is not affected significantly by the recession.
growth, unemployment, OECD, potential output, Great Recession, hysteresis
The negative impact of the financial crisis on potential output necessitates an EU-led policy response
Declan Costello, Gert Jan Koopman, Kieran Mc Morrow , Gilles Mourre, István P. Székely, Alexandr Hobza 15 July 2009
The crisis may reduce the EU’s potential output by 5% of GDP or more. This column warns that the crisis may permanently reduce the EU’s supply-side capacity unless policymakers respond with reforms. It outlines measures to address the crisis and address long-run concerns about demographic shifts, public finances, and climate change.
The IMF’s most recent forecasts project that the EU’s GDP will fall 4.7% this year and continue to shrink (-0.1%) in 2010 (IMF, 2009). Financial market turbulence, credit shortages/deleveraging, higher unemployment, and steep reductions in activity in certain industries as resources reallocate will inevitably lead to a non-negligible short-run (i.e. 2009/2010) loss in the supply-side capacity of EU economies.
climate change, demographic ageing, public finances, EU reform, potential output