The Crisis through the Lens of History

• Author: Charles Collyns
• Position: Deputy Director in the IMF's Research Department
• Pages: 18-20

The current fi nancial crisis is ferocious, but history shows the way to avoid another Great Depression

Page 18

Economic history is back in vogue. In the fi rst half of 2008, surging prices of oil and other commodities revived unhappy memories of the stagfl ation of the 1970s. More recently, the extraordinary intensification of the global fi nancial crisis since the mid-September collapse of Lehman Brothers has brought back an even more ominous specter from the past-the Great Depression of the 1930s.

Comparing the present financial crisis to the deepest and most devastating economic cataclysm in modern history may seem a stretch, but there is now no question that the ongoing crisis has become the most dangerous of the post-World War II era. It is not so much the depth of the downturn in individual countries-devastating financial collapses have occurred before in advanced as well as in emerging economies-but its pervasive reach into all corners of the world economy that has created a threat to global prosperity not experienced in 70 years.

But how large is the present financial crisis by past standards? And, crucially, what will be its likely economic impact and what can be done to contain the damage and pave the way for economic revival? Economic history can help answer these questions, offering both a useful perspective for understanding the relative magnitude and seriousness of the current crisis and invaluable lessons that can be applied to resolving it.

Not quite the Great Depression

One metric that gives a sense of the current crisis is the scale of the financial losses involved. The IMF's latest Global Financial Stability Report (IMF, 2008) estimates that losses on U.S.-based mortgage-related and other credits will add up to $1.4 trillion, based on market prices in mid-September. Such losses would be the largest experienced in dollar terms of any post-war fi nancial crisis. Moreover, they are likely to end up considerably higher after taking account of the intensification of the financial crisis across global markets since mid-September. Nonetheless, the losses are not as high in percent of GDP as those suffered by some individual countries during deep crises in the past (see Chart 1).

Another measure is the degree of market stress. The IMF's October 2008 World Economic Outlook (Lall, Cardarelli, and Elekdag, 2008) calculates an index of financial stress, calibrated for 17 advanced economies since 1980. This index-available through September 2008 and covering variables such as interbank spreads and equity and bond market performance- has reached a level comparable to previous peak periods of stress across the range of countries. What is even more striking is that the stress has already been sustained at very high levels for almost a year and has affected all the countries in the sample (see Chart 2). And, since September, the strains have spread dramatically to emerging economies...