Board of Governors of the Federal Reserve System

June 22, 2021

The Global Recovery: Lessons from the Past

Dario Caldara, Matthew DeHaven, Francesco Ferrante and Matteo Iacoviello¹

The downturn in global economic activity caused by the COVID-19 pandemic was unique both for its causes and for its severity. Even though, on a global scale, the recent contraction is unprecedented in modern times, it is useful to look at the consequences of large recessions which affected individual countries in the past. In this note, we draw insights about the ongoing global recovery by looking at the evolution of several economic indicators in the aftermath of past recessions.

We find that, following severe contractions, output typically remains well below its pre-recession trend in the medium term. This behavior is more marked for severe recessions that are accompanied by financial crises, while severe but short contractions result in a faster recovery. The post-COVID-19 recovery appears to be much more rapid than in standard severe recessions, putting it roughly in line with severe and short recessions of the past.

We argue that outsized policy interventions in response to COVID-19 provided unprecedented support to households and firms, preventing a more prolonged downturn. Furthermore, productivity is likely to be more resilient compared to past slumps, which should help to sustain the pace of the recovery in the coming years.

Recoveries Following Severe Recessions

We consider recession episodes in 56 advanced economies (AEs) and emerging market economies (EMEs).² We employ quarterly data between 1947 and 2019, obtaining 9,805 observations for real GDP. Studying recovery dynamics at a quarterly frequency, rather than at a yearly frequency, allows us to make a more direct comparison with the COVID-19 recession, in which an unprecedented global contraction in the first two quarters of 2020 was followed by an equally unprecedented rebound in the second half of the year.

Table 1 summarizes the nature of the recessions in our data. We identify a total of 246 recessions, 183 of them in the AEs and 63 in the EMEs.³ The average decline in GDP in these episodes was about 4.4 percent, with contractions being more severe in EMEs than AEs. About one tenth of these recessions were "severe," and featured an average GDP decline of about 15 percent, a magnitude that is comparable to what occurred in many economies during the first half of 2020.⁴ Table 1 also illustrates that half of the severe recessions were "severe and financial" recessions, in which the downturn was accompanied by a financial crisis, while half of them were "severe and short" recessions, in which one quarter of positive growth followed a large two-quarter decline. ⁵

Table 1: Nature of Past Recessions

Following a severe recession, economic activity typically experiences a long-lasting drag. As shown by the red line in figure 1, on average, GDP remains about 15 percent below its pre-recession trend three years after the onset of a severe recession.⁶ Severe and financial recessions tend to have even greater persistent negative effects on GDP (green line), as documented in well-known studies.⁷ By contrast, "severe and short" contractions are followed by more rapid rebounds. Nonetheless, even these shorter recessions usually leave the level of GDP about 5 percent below pre-crisis trend after three years.

Figure 1. GDP Recovery after “Severe Recessions”

The current recovery outperforms those from typical severe recessions. Figure 1 compares the ongoing global recovery, and its projected path, with the historical evolution of GDP in the aftermath of severe contractions. Given the sharp rebound in economic activity in the second half of 2020 (solid portion of black line), the recovery from the COVID-19 shock has so far outperformed those from typical severe recessions, suggesting that this episode may look more like the "severe and short" recessions rather than the "severe and financial" ones.⁸ Indeed, the average foreign GDP forecast from the IMF April 2021 World Economic Outlook (dashed portion of black line) lines up well with the recoveries from severe and short contractions.

There is important heterogeneity across recoveries from severe recessions. In table 2, we report the number of contractions which were followed by "overshooting recoveries", that is a recovery with output rising above its pre-recession trend within three years. As shown in the first row of table 2, only about one third (70 out of 246) of total foreign recessions were followed by an overshooting recovery. However, most of these overshooting episodes occurred after shallow contractions.⁹ When we restrict our sample to severe recessions, overshootings are more rare, representing less than one fourth of such episodes (5 out of 22), mostly in the EMEs.¹⁰ As shown in table 2 and in figure 2, and in line with the evidence in figure 1, overshootings are even rarer (2 out 11) following severe and financial contractions, while they are more common (4 out of 9) after severe and short contractions.

Table 2: Past Overshooting Recessions

Figure 2. GDP Paths of "Severe Recessions"

Policy Responses and the post-COVID-19 recovery

The relatively benign outlook for the post-COVID-19 recovery may be the result of the aggressive and broad measures enacted by foreign governments and central banks in response to the COVID-19 pandemic.

Central banks interventions supported market functioning and access to credit, avoiding widespread financial turmoil. Expansionary monetary policy, massive liquidity provision and targeted credit support contributed to stabilize financial conditions and reduce volatility across many countries.

Discretionary fiscal responses amounted to more than 20 percent of GDP in AEs and almost 10 percent in EMEs, where policy space is more limited, as shown in figure 3. These fiscal interventions provided extraordinary support to the balance sheets of firms and households. For example, strong government support for businesses, through grants, loans, and moratoriums on debt repayments, contributed to an unprecedented—relative to past recessions—reduction in bankruptcies in most AEs (figure 4).¹¹ These measures limited the deterioration in firms net worth and will likely sustain investment growth. In AEs, fiscal policy provided substantial backing to households disposable income, which held up considerably better compared to previous downturns (see figure 5), and which even increased in a few countries during 2020. The resulting increase in savings should boost consumer spending once health restrictions are lifted, bolstering the pace of the recovery.

Figure 3. Discretionary Fiscal Response to COVID-19

Figure 4. Bankruptcies in Past Recessions

Figure 5. Household Disposable Income in Past Recessions

The Role of Productivity

The evolution of productivity will also be important in determining the speed of the current recovery. Previous severe recessions resulted in long-lasting declines in labor productivity, which hindered the rebound in activity. After severe recessions, average labor productivity usually remains 4 to 9 percent below its pre-recession trend three years after the start of the crisis (figure 6). Large downturns can affect productivity through several channels, including scarring effects on human capital, lower innovation, and capital misallocation.¹²

Figure 6. Labor Productivity in "Severe Recessions"

The implications of the COVID-19 recession for productivity are difficult to predict.¹³ Following a large decline in the first half of 2020, output per hour rebounded strongly in the second half of the year (the black line in figure 6). Several studies suggest that the COVID-19 pandemic may bring about structural changes and cleansing effects that can offset the decline in productivity typically associated with sharp contractions, providing further support to the recovery in the coming years. For example, the exit of unproductive firms might foster reallocation toward more productive businesses and industries, though one side effect of the policies used to support troubled firms during the pandemic might be that unviable companies are kept operating longer than necessary.¹⁴ In addition, digitization and automation accelerated in several companies as a result of the pandemic. Finally, many firms may opt for a permanent shift toward new flexible working arrangements, including remote working, which, together with the adoption of new technologies, could increase the productivity of many workers.¹⁵

References

Jose Maria Barrero, Nicholas Bloom, and Steven J. Davis (2020), "Why Working from Home Will Stick," BFI Working Paper 2020-174

Nicholas Bloom, Philip Bunn, Paul Mizen, Pawel Smietanka, and Gregory Thwaites (2020), "The Impact of Covid-19 on Productivity," NBER Working Paper Series 28233.

Valerie Cerra and Sweta Chaman Saxena (2008), "Growth Dynamics: The Myth of Economic Recovery," American Economic Review, vol. 98 (March), pp. 439–57.

Alistair Dieppe, Sinem Kilic Celik, and Cedric Okou (2020), "Implications of Major Adverse Events on Productivity," Policy Research Working Paper 9411.

Robert Martin, Teyanna Munyan, and Beth Anne Wilson (2015), "Potential Output and Recessions: Are We Fooling Ourselves?" International Finance Discussion Papers 1145

Albert Queralto (2020), "A Model of Slow Recoveries from Financial Crises," Journal of Monetary Economics, vol. 114 (October), pp. 1–25.

Luc Laeven and Fabian Valencia (2020), "Systemic Banking Crises Database II," IMF Economic Review, vol. 68 (June), pp. 307-61

Mack, A., and E. Martínez-García. 2011. "A Cross-Country Quarterly Database of Real House Prices: A Methodological Note." Globalization and Monetary Policy Institute Working Paper No. 99, Federal Reserve Bank of Dallas.