Large financial shocks that occurred during the 2007-08 financial crisis may have caused losses too great for the US economy to recover, according to an economic letter released by the Federal Reserve Bank of San Francisco.
Researchers noted that the US economy has failed to grow according to pre-crisis trends 10 years after the last financial crisis and recession. They cited the large losses in the economy’s productive capacity after the crisis as one of the possible reasons.
The US economy’s level of output is unlikely to return to its pre-crisis trend level given the size of losses in productive capacity, which represents a lifetime present-value income loss of about $70,000 for every American.
According to the analysis, America’s GDP would have behaved differently if not for the large adverse financial shocks experienced during the crisis. GDP behavior might have resembled the less severe 1991 recession, which saw GDP only drop by 1.5% and return near pre-crisis level in just a few years.
The researchers admitted that they still do not have a good grasp on how financial market disruptions can have such persistent effects on output. They cited the highly peculiar behavior of economies with financial frictions as one possibility. Another theory is that the economy’s future productive capacity is permanently affected by the cuts businesses are forced to make on research expenditures due to financial distress.
“Financial market disruptions can have large costs in terms of societal welfare by causing persistent losses in the level of GDP,” the researchers wrote. “This suggests that finding ways to prevent or contain future financial crises is an important research and policy priority.”
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