1.Introduction
This essay is based on the financial crisis from 2007 to 2008, which discuss whether the time at that moment is different. Here, we focus on the financial crisis happened in USA around these two particular years, therefore we mainly talk about ‘U.S Sub-prime Crisis’. Section I is to summarize the ideas that Reinhart and Rogoff provide according the book ‘This Time is
Different: Eight Centuries of Financial Folly’ (2011) and their working papers. Section II is to evaluate and counter critically toward their argument. Also, a conclusion will be drawn after these two sections.
2.Section I
The basic idea that Carmen M. Reinhart and Kenneth S. Rogoff suggests is that what happened in 2007 and 2008 was nothing different from previous financial crisis. They consider financial crisis can be traced by past experience from different countries around the world as usual.
Their book and working papers introduce massive historical database which have constructed to study the debt (both external and internal), banking crisis, inflation, currency crashes and so forth. There are sixty-six countries included in the data, such as Africa, Asia, Europe, Latin
America, North America, and Oceania (Reinhart and Rogoff, 2008).
They studied various types of financial crises, however, the book mainly includes sovereign defaults and banking crises as these two forms of crises are particularly relevant to modern society. They covered government debt defaults in eight centuries all over the world as the title of the book.
Basically, their views in term of the financial crisis in 2007 and 2008 are that the U.S Subprime
Meltdown and the so-called ‘ The Second Great Contraction’ was inevitable. They criticized that if the policy markers could do some research on the recent history of financial crises, then the whole society might have some protection about it.
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The reasons why Reinhart and Rogoff think U.S government and citizens could not predict the crisis are because the majority of people thought development in financial engineering and the improvement in the conduct of monetary policy could contribute to tame business cycle and reduced risk of financial contagion ( Reinhart and Rogoff, 2011). In addition, government, firms and some economists were overconfident and dependent on the public’s expectation of future events, which create obstacles on the way to predict the severe financial crisis at the time. What is more, they consider the only warning signal of this meltdown was not the vast number of debts borrowing from the outside of America. As the matter of fact, the economy of U.S showed many other signs of the crisis such as asset price inflation, and rising house hold leverage. Other countries like UK, Spain also showed the warning signs as well. To be specific, Reinhart and Rogoff made use of their data to prove their opinion and develop a new crisis index to conclude how much number crisis happened in different countries across the global.
They compares the U.S sub-prime financial crisis with past financial crisis. Especially, they emphasis an argument whether the conduct of borrowing from foreign countries in terms of
United States should have been seen as a waning signal. Firstly, they stand on a wider perspective to review the early banking crisis. For example, the banking crisis in India in
1863 and other early developing countries. They suggests that since the liberalization of finance and international capital account, which reduce and eliminate the barriers of domestic and foreign investment rooting in the world so that the banking crisis appeared. As we all know, the basic reason of U.S financial crisis in 2007 and 2008 was the bubble in the real estate market, which caused by increasing prices of the houses and an vast cheap foreign capital, furthermore, an gradually permissive regulatory policy. They drew a diagram to illustrate that it cannot compare any increased pricing of housing in any year to that in 2007.
Therefore, it eventually triggered a worldwide financial panic.
Reinhart and Rogoff suggests that the reason why people thought ‘this time is different’ was people believed the case in United States would be special, which need a detail consideration.
Some policy markers, experts and even chairman Greenspan in United States did not took the
U.S current account deficit as priority and they insisted they should not overreact about it.
Most of the people in USA were holding an optimistic attitudes. However, Reinhart and
Rogoff then found out the phenomenon of the rising asset prices, the activity of slowing economy, dramatic current account deficits are all the vital warning sings to the financial
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Page 4 of 7 crisis which the people in United Stated could not ignore and they assert that this is another evidence to prove the time is nothing different from previous years. They also claims that the financial crisis hardly occur with no reason, whereas it usually occur after a slow pace of the economy. As is showed in their book, in 2007, the United Stated follow the same ‘V’ shape as the earlier crisis. In fact, when the economy in United Stated slowed down in 2007, it still closely related to the pattern of all crisis. In 2008, the situation was worse, the growth rate of slowdown economy witnessed a rapid increases. They concluded that all the standard index and signals before 2007 showed obviously that United Stated was be in a higher level of risk inducing a severe financial crisis. According to the works, they insists the financial crisis in the past could help to predict the incidence in 2007 and 2008, which will end up to a financial crisis as before, therefore the time is the same in terms of the past experience.
3.Section II
Although Reinhart and Rogoff (2011) thought they came up with unassailable argument, there are some limitation and criticism toward their study. As they admitted in their book, the historical data of government debt in domestic was not easy to collect for most countries, thus the standard data sets was limited in some aspects. Some people also think the database is massive which is overwhelming (Warsh, 2010).
The important drawback of their analysis is he relationship between public debt and economic growth, which is including basic coding errors. They suggests high government debt ratios
(exceeding 90 percent) would lead to low economic growth ( Reinhart and Rogoff, 2010).
Unfortunately, GDP data for most countries before than the twentieth century are quite uneven. Thus,data are only available sporadically and at long intervals, which is especially limiting in trying to assess the impact of crises in most of the emerging markets. An Professor of Economics in University of Missouri-Kansas thought that Reinhart and Rogoff had no idea what sovereign debt is. They simplistically combine government debts, fixed exchange rates as well as floating rates to demonstrate their statement.
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Moreover, it is not even possible to see what exactly is from their book exactly government debt versus private debt from their book (Wray, 2013).
Also, another critical analysis of their work replicated the process that Reinhart and Rogoff study and finally found the coding error and they proved that, in the case, the average real
GDP growth rate for countries carrying a public-debt-to-GDP ratio of over 90% is actually
2.2% rather than 0.1% as published in the book. They suggests Reinhart and Rogoff made a significant errors in reaching the conclusion that countries facing public-debt-to-GDP ratios more than 90% will suffer from a major decrease in GDP growth. Specifically speaking, it would not totally different in the situation when the ratio is low to if the average GDP growth at public debt ratio are greater than 90% (Herndon, Ash and Pollin, 2013).
On the other hand, Reinhart and Rogoff relied to the critique later that they acknowledged the calculation error but we strongly deny the other accusations. They arrested that these critics overlooked the report that they included both median and average estimates for growth, at different level of debt which is link to economic output, going back to 1800. Also, they thought these critics neglected to their paper which published in 2012. In that paper, they did a more careful calculation and their research was more up-to-date. It states that an average estimate for growth rate would be 2.3% when a debt-to-G.D.P. ratio exceeds 90%, which is similar with the result as the critics, Herndon, Ash and Pollin did (Reinhart and Rogoff, 2012).
What is more, people in United States have a positive attitude before the financial crisis in
2007 and 2008 are reasonable, which means there did have some factors to support ‘the time is different’. In the first place, the financial system and political system in United Stated are innovative and strong, and they have the largest and most liquid capital market, so it gave people many beliefs that they would be fine. Secondly, the increasing economies needed to diversify their funds. At the meanwhile, the global financial integration allow counties to rely more on debt. Thirdly, people often follow the ideas of policy makers especially they are superior in United States. Finally, many new borrowed were allowed to enter mortgage markets by new financial instruments at that time. Additionally, people thought all the changing was due to the innovation, therefore they did not think highly of that (Reinhart and
Rogoff , 2011).
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Martin Wolf, chief economics commentator at the Financial Times, London, commented on the works of Reinhart and Rogoff that although the authors made so much efforts on collecting the data, they were disappointed to put even a small proportion of their revenues into this initial task (2009).
He also evaluate their works and he actually supports their ideas, mentioning four lessons that the data tell us as well. Firstly, he absolutely agreed that we had been there before. He suggests the story will not change though the detail might change. Secondly, He thinks the data tell us how inflation and default on foreign debt would be if the domestic public debt changes simultaneously. The third lesson is, on average, government debt climb by 86% during the three years following a banking crisis. As the matter of fact as authors mentioned the crisis in the U.S was definitely the same what history would have led us to expect. At the final lesson, he insist from the data we can see the bad thing will happened together, argued by the authors, it is not surprising to see the outcome (Wolf, 2009).
4.Conclusion
According to Reinhart and Rogoff’s study, they have construed huge datasets and they concluded that ‘we have been here before’. Admittedly, many ‘red light’ they mentioned were flashing well before the financial crisis, and many experiences of crisis were warning them to be careful, which might result in a serious financial crisis. No matter how strong the financial system is, Reinhart and Rogoff believes that every financial crisis will be nothing different, the consequence is the same referring to their research. And many critics like Cardiff Garcia
(2013) still think the book ‘This Time is Different’ remains a highly valuable contribution to the study of finance crises. Nevertheless, other critics provided some evidence to deny their idea in their works. Overall, it generally believe that the financial crisis in 2007 and 2008 was related to the earlier crisis, however, we should critically consider that whether that time was totally the same as before.
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