 of factors including fiscal stimulus and strong exports to Asia. In other words, by going early, going strong and going households plus by being lucky, in that China also opted for an expansionary fiscal stance pouring yuan into energy and steel-hungry infrastructure construction.
That expansionary strategy successfully carried China through the GFC. But, it came with a considerable legacy cost in terms of a property bubble inflated by debt courtesy of a lightly-regulated shadow banking system.
From the petro-dollar recessions of Latin America in the 1980s to Japan in 1990 and the Asian contagion of 1997, we have seen how debt–driven recessions struggle to recover compared with inflation or inventory cycle recessions.
The more extended the struggle, the more likely it is for hysteresis to be an issue. In such recessions, the rate of capital accumulation is sharply reduced. Labour markets are particularly vulnerable, often with long-term consequences that are most apparent in declining participation.
It is also common to have a slowdown in the growth of total factor productivity as businesses are slow to move to more technologically advanced equipment.
Naturally all of these developments feed into financial markets.
Japan since 1990 provides the best case study in the way in which hysteresis can emerge in a weakened economy that provides an ideal habitat.
Ball’s simple model of the power wielded by hysteresis is dependent for its credibility on the official growth estimates of the IMF and OECD.
These have been revised down across most countries of late. If correct, that would make the outlook worse and the potential damage to the global economy all the greater. As Nobel laureate Paul Krugman wrote last week: “One possibility is that the output gap numbers are wrong; we’re actually having a very hard time figuring how much slack there is.
“Another possibility is that it’s just a coincidence that underlying growth slowed at the same time as the crisis. But if you take the numbers seriously, they do seem to indicate that hysteresis – short-term shocks quasi-permanently hurt the economy’s potential – is a very big issue."
The Australian Financial Review