July 15, 2020

Global Letter – The economic cost of recessions II

BY John Llewellyn, Russell Jones

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Recessions are expensive. Output is permanently lost; and often potential growth is reduced too.

In an earlier Global Letter, 1 we reproduced path-breaking calculations made for the UK by the late Christopher Dow. Studying the evolution of post-recession, constant-employment, real output Dow concluded that each recession resulted in a persistent loss of output relative to what would have obtained had real GDP remained on its pre-crisis trend.

Over time, these losses cumulated: in the pre-WWII period the shortfall of actual GDP below trend was 2.2% following the 1920-21 recession; widening to 4.5% following the 1929-1932 recession. For the post-WWII period, Dow’s estimates of the ‘persistent’ output loss were: 2.2% following the 1973-75 recession; widening to 5.4% following the 1979-82 recession, and widening yet further, to 8.4%, following the 1989-93 recession. Extending Dow’s analysis to the 2008-2010 recession indicates a yet further widening, to 15%. And of course the likelihood is of yet more losses after the massive COVID-19 downturn.

While Dow was writing about the UK, his basic approach has been followed many times since, albeit by a variety of somewhat different methods. 2 Dow’s basic finding turns out to have wide generality – over time and across countries. Typically, when an economy has recovered from a recession real GDP is, and remains, several percentage points below where it would have been had it remained on its original pre-recession path – so-called ‘persistent’ GDP loss.

Thus the OECD, examining all 34 of its member countries over the period following the 2008 Global Financial Crisis, estimated a median loss in aggregate potential output of about 3½ per cent; and of about 5½% for the subset of 19 OECD countries that directly experienced the banking crisis. That said, the extent of the loss differed widely across countries. The most severely affected were overwhelmingly smaller European, mainly euro area, countries, many experiencing reductions of around 10%. At the other extreme, Germany and Japan apparently experienced little or no adverse effect on potential output. 3

The IMF, examining several decades of data for a wider group of 190 countries, both developed and developing, found the persistent loss in output to have been on average about 5 percent points of GDP in the case of recessions caused by balance of payments (BOP) crises, 10 percent for recessions caused by banking crises, and 15 percent following ‘twin’ crises. 4

Sometimes recessions prove even more costly, resulting not only in a persistent loss of output relative to the extrapolated trend level but, also a reduction in the (post-crisis) trend rate of growth. The UK (see figure) is a typical case. More generally, the IMF found that the average growth rate after a recession was about a ½ percentage point lower in the first four years of recovery than the average growth rate for all expansion years. 5

Bottom line: recessions are expensive – a classic case of “A cost that you don’t pay but do experience.”

Global Letter - The economic cost of recessions II 1

Technical note

A technical note, providing more information on the method is available upon request.


1 Llewellyn. J. and Park. S. 2020. The economic cost of recessions. June 1. Llewellyn Consulting. Available upon request.

2 The OECD, for example, calculates a series of potential output from an estimated production function, and examines the actual GDP relative to that series. The IMF, by contrast, fits a linear trend to the pre-recession period, and looks at the subsequent path of actual GDP rather than constant-employment GDP.

3 See Ollivaud, P., and Turner, D., 2015. The effect of the global financial crisis on OECD potential output , especially p. 42 and Table 1. Available at https://www.oecd.org/economy/growth/the-effect-of-the-global-financial-crisis-on-oecdpotential-output-oecd-journal-economic-studies-2014.pdf [Accessed 12 July 2020]

4 See Cerra, V. and Saxena, S., 2017. Booms, Crises, and Recoveries: A New Paradigm of the Business Cycle and its Policy Implications. IMF Working Papers, 17(250), p.6. Available at https://www.imf.org/en/Publications/WP/Issues/2017/11/16/Booms-Crises-and-Recoveries-A-New-Paradigm-of-theBusiness-Cycle-and-its-Policy-Implications-45368 [Accessed 12 July 2020]

5 As the authors observe: “Output does not cycle around a long-term upward trend. Instead, shocks result in complete shift in the trend line itself. In short, the “business cycle” is not a cycle.”

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