Carmen Reinhart and Kenneth Rogoff analyze long-run crisis data to find the root causes of financial crises for better bank capital regulation and asset market stabilization.

Laura Hermes

2023-06-28 09:29:00 Wed ET

Carmen Reinhart and Kenneth Rogoff delve into several centuries of cross-country crisis data to find the key root causes of financial crises for asset market stabilization and bank capital regulation.

Carmen Reinhart and Kenneth Rogoff (2011)


This time is different: several centuries of financial folly


Harvard macrofinance professors Carmen Reinhart and Kenneth Rogoff delve into many centuries of financial crises from the Middle Ages to the modern era in global macrofinancial history. The main thesis shows how history can offer not only useful perspective, but also prescient forward guidance in the aftermath. Through this in-depth informative analysis, Reinhart and Rogoff help inspire original empirical work in long-run macrofinancial history. In an empirical view, Reinhart and Rogoff set a higher bar for a comprehensive quantitative historical treatment of financial crises. In contrast to the typical narrative and case-specific methods of financial history by Barry Eichengreen and Charles Kindleberger, Reinhart and Rogoff look for the key general truth that might arise from a panoramic large-sample view. The Reinhart-Rogoff scope of empirical work is very long in terms of time. There is full coverage of pre-1800 macroeconomic events to support the common claim in the book title. After 1800, Reinhart and Rogoff undertake meticulous empirical work to analyze a comprehensive database for 66 countries. The main financial crises include bank, sovereign debt, and currency crises. Reinhart and Rogoff further consider several macrofinancial covariates such as economic output, inflation, exchange rates, and interest rates etc.

From a methodological perspective, the most fundamental and forceful thesis from Reinhart and Rogoff is that global economic history comprises pervasive, episodic, and recurrent sovereign debt, bank, and currency crises in rich and poor countries. These global financial crises are rare events in association with severe economic recessions. From the chambers of power to our academic analysis of global macro financial history, we can learn from the deep Reinhart-Rogoff empirical thesis that substantive cross-country evidence shows rare but episodic crises in the financial system. Reinhart and Rogoff suggest that we can perhaps understand these rare events properly across both space and time. We need to assess the modern macro regimes and institutions in order to better understand dynamic processes at work. In this positive light, Reinhart and Rogoff offer long-term evidence for 66 countries. In this much broader long-run cross-country context, financial crises tend to recur on the basis of common fault lines in the macrofinancial system.


Reinhart and Rogoff differentiate bank crises, inflation crises, currency crises, and sovereign debt crises in global macrofinancial history from the Middle Ages to the modern era.

Reinhart and Rogoff start their panoramic analysis by defining the basis of financial crises in all their varieties. Inflation crises refer to the rare cases of well above 20% persistent and general price increases per year. This definition serves as a rather low bar for post-war fiat money episodes, but suitably calibrates inflation bursts in the earlier metallic eras. Currency crashes relate to substantial 15%+ fluctuations in exchange rates. Also, the currency debasement event threshold for metallic eras targets 5% or more exchange rate fluctuations. In most fiat money eras, these rare events relate to core currency control reforms that bring about currency conversion usually from currency pegs to flexible exchange rates. Bank crises are binary rare episodes of substantial default events in the financial system. Ubiquitous bank runs, failures, open recapitalizations, mergers, acquisitions, or large-scale government bailouts often turn out to be the norms in these bank crises. In these rare episodes, banks, insurers, and other non-bank financial institutions lose substantial principal and interest loan payments. Reinhart and Rogoff further contribute to the long-term study of bank crises by including an in-depth chronology of not only external bank defaults but also narrative details on many domestic debt defaults.

Reinhart and Rogoff introduce the rare but unique concept of debt intolerance. The basic thesis rests on the empirical relation between debt levels and bank defaults. This relation structurally differs between OECD countries and non-OECD countries. In most OECD countries, the national debt-to-GDP ratios often tend to land in the reasonable range of 125% to 150%. However, bank crises can recur at much lower levels of national debt-to-GDP ratios in most non-OECD countries. The East Asian financial crisis of 1997-1998 and the currency crises in Argentina and Russia serve as good examples of this distinction between OECD and non-OECD countries. In particular, Reinhart and Rogoff further contribute to the long-run empirical study of root causes of economic growth. For both OECD and non-OECD countries, there is a robust negative relation between real GDP economic growth and national debt-to-GDP, especially if the national debt-to-GDP ratio exceeds 90%. This important empirical result suggests that there can be an optimal range of debt-to-GDP ratios for the productive uses of fiscal deficits and debt levels to help promote economic growth and prosperity in the long run. This result poses a conceptual challenge to the naïve view that many countries can continue to fund government expenditures with incessant fiscal deficits in the lofty pursuit of economic growth. At some point, economic growth deteriorates with general price inflation risks as fiscal deficits add to national debt levels in due course. Overall, Reinhart and Rogoff offer a negative determinant of cross-country economic growth by finding the special adverse ripple effects of high debt-to-GDP ratios on real GDP economic growth. In a fundamental view, fiscal policies, fiscal stimulus programs, and other government expenditures cannot increase with no broader repercussions on economic growth and prosperity. When push comes to shove, the basic law of inadvertent consequences counsels caution.

Reinhart and Rogoff present their long-run analysis of the gradual accumulation of substantial American dollar foreign reserves. Non-OECD countries should learn to tilt their capital inflows of foreign direct investment from fickle debt funds to greater long-term capital investment projects. Since the new millennium, several countries such as Mainland China, Japan, Switzerland, Russia, Saudi Arabia, Taiwan, Hong Kong, India, South Korea, and Brazil have become the largest holders of American dollar reserves. With stronger central bank balance sheets, these countries almost eliminate aggregate currency mismatch, misalignment, and even manipulation etc because flexible exchange rates better balance global trade flows, capital accounts, and nationwide fiscal and monetary stimulus programs. In recent decades, these countries have taken incremental steps to eradicate their national debt intolerance in the lofty pursuit of both robust economic growth and prosperity in their respective trade blocs.


Sovereign debt crises often emerge from the recurrent rollout of short-run external debt, illiquidity, and insolvency in the capital account.

Why does the government ever meet principal and interest obligations on external national debt? The policy discussion evolves to become the pervasive problem of rolling short-term national debt, illiquidity, and insolvency in the capital account. In practice, the problem highlights the common fragility of macrofinancial ecosystems. In theory, multiple equilibrium steady states can emerge from this broader context. Reinhart and Rogoff assess the 66-country post-1800 crisis data, offer an overview of external debt default patterns, and then justify their coincidence with bank crises. In fact, it is quite common to find simultaneous distress in both areas. Sometimes these external debt defaults and bank crises coincide with inflation crises. In these special instances, this coincidence shows that the government can systematically relieve fiscal distress through not only external debt default but also some recourse to seigniorage. Specifically, Greece has been in technical default for about 50% of the time, and many Latin American countries have been in technical default about 25% to 65% of the time in global economic history. The relatively clean crisis record of most Asian countries turns out to be a rare and unique exception to the heuristic rule of thumb worldwide. America, Britain, Canada, Europe, and Japan can further serve as good examples of crisis-free trade zones most of the time over 8 centuries (except the Global Financial Crisis of 2008-2009 and the recent rampant pandemic corona virus crisis of 2020-2021).

Outside most OECD countries, many external debt defaults have occurred at low thresholds. Total debt tends to be high and usually about twice as high as external debt on the rise. Significant long-term domestic debt can probably exacerbate the temptation for the government to inflate general prices in many countries. In reality, these countries inflate away public debt, tolerate high inflation, and so help reduce fiscal distress from time to time. Specifically, some fiscal policy integration requires a common Treasury across Europe. Just as the European Central Bank operates as the monetary policy authority in the trade bloc, a European Treasury can reduce fiscal distress in some countries such as Portugal, Italy, Greece, and Spain (PIGS) with better fiscal integration of government expenditures on health care, education, infrastructure, and research and development etc. These European countries can probably adapt their inclusive institutions to empower all citizens to apply their best skills and talents in productive work. This empowerment helps promote better real GDP economic growth and prosperity in the long term. As a result, these countries can help gradually alleviate the fiscal distress concern in due course.


Bank and currency crises often arise from asset bubbles and capital flows across countries at specific historical junctures.

Real economic shocks such as warfare and productivity retrenchment may be the ultimate source of bank crises. In turn, bank crises can amplify these real economic shocks. Thus, Reinhart and Rogoff are careful not to overstep on claiming causality. Correlation may or may imply causation. However, some bank crises follow asset bubbles and sudden capital inflows. This fragility often reflects the weakest links in the macro financial system. Just as both rich and poor countries have experienced inflation-driven currency crises in recent decades, bank crises have been a central recurrent feature in the global economic history of both rich and poor countries. In this fundamental sense, the graduation from sovereign default and inflation crises might be a distinctive feature of OECD countries, but Reinhart and Rogoff cannot blithely assume that the same is true for bank crises. Most economists can attribute the Global Financial Crisis of 2008-2009 to cross-country contagion risk from the subprime mortgage crisis in America, Britain, and so forth. The rare episode hence serves as the exception to the heuristic rule of thumb for bank crises worldwide.

Reinhart and Rogoff place bank crises in the broader context of stock market and residential real estate price boom-bust business cycles. Stock market prices often tend to recover quickly after financial crises even in real terms. This reflation arises from monetary policy stimulus in the form of both low interest rates and large-scale asset purchases. The residential real estate price cycle is much more sluggish. It can take many years for house prices to stabilize without full recovery to the peak. From time to time, prudential bank capital regulation can contribute to better asset market stabilization.

At the same time, fiscal deficits and government debt mountains tend to increase dramatically after financial crises. The lost economic output and fiscal damage can serve as the real economic welfare costs of bank crises. These macro costs prove to outweigh the micro costs of bank bailouts. When push comes to shove, the basic law of inadvertent consequences counsels caution. There are many different ways for economists and politicians to skin the cat for bank crisis resolution, and all roads eventually lead to Rome. No one can build Rome in one day.

The Global Financial Crisis of 2008-2009 seems to arise as a natural result of the subprime mortgage debacle in America, Britain, Canada, and Europe etc. Reinhart and Rogoff identify only 6 main global crises in the last 200 years: the default crisis of 1825-1826, the Panic of 1907, the Great Depression of the 1930s, the debt crisis of the 1980s, the East Asian financial crisis of 1997-1998, and the Global Financial Contraction of 2008-2009. This identification might have been quite fortuitous, and Reinhart and Rogoff deserve great credit for putting together a set of very prescient guideposts to the economic maelstrom in these rare global crises. In response to the Global Financial Crisis of 2008-2009 in America and Britain, central banks and national treasuries launch extraordinary fiscal and monetary stimulus programs for asset market stabilization and bank capital regulation. Monetary stimulus policies include near-zero or even negative interest rates and large-scale asset purchases. Treasury capital inflows further help ease the common fiscal distress concerns. In combination, this fiscal and monetary policy coordination can help ameliorate the macro economic woes of subprime mortgage defaults in the Global Financial Crisis of 2008-2009.


Reinhart and Rogoff analyze and discuss the central public policy lessons for fiscal, monetary, and macrofinancial control programs.

Reinhart and Rogoff provide not only their empirical analysis of global crises in the long run, but also the core policy lessons for fiscal, monetary, and macrofinancial government agencies worldwide. First, some key early warning indicators deserve greater scrutiny. For the ongoing reassessment of macrofinancial conditions, these early warning indicators help identify the optimal trade-offs in monetary and macro financial policies in response to rare disasters on the basis of economic costs and benefits. Recent empirical work includes core composite early warning indicators such as the term spread, the default spread, the S&P 500 P/E ratio, Fama-French fundamental factors for the global stock market, Treasury bond yield curve control, U.S. dollar relative strength index (RSI), Fibonacci retracement, moving average convergence and divergence (MACD), and so on. Some recent empirical evidence suggests that deeper recessions often tend to follow credit booms ceteris paribus. The private-credit-to-GDP ratio proves to be another useful early warning indicator in the broader context of global crises.

Second, supra-national institutions such as the International Monetary Fund (IMF), World Bank, OECD, and Bank for International Settlements (BIS) can collaborate on multilateral solutions and responses to global crises. With enough political clout and power, fiscal and monetary policymakers coordinate their joint efforts to avert rare disasters such as the Global Financial Crisis of 2008-2009 and the pandemic corona virus crisis of 2020-2021. There should be a greater role for the IMF to help advance greater transparency and discipline on most countries before global crisis eruption. Supra-national macro financial cooperation can help a great deal on bank capital, insurance, and short-term liquidity provision with some fiscal form of trans-national support.

Third, global crisis graduation is not easy. Many economists and politicians might have been too naïve to think that their government programs have already solved most macro financial problems and recessions during the U.S. subprime mortgage boom back in 2005-2006. These experts sometimes think that this time is different. However, global economic history shows that numerous sovereign debt, inflation, bank, and currency crises tend to recur at particular historical junctures in both rich and poor countries.

Fourth, financial crisis recessions are often worse than regular recessions. Global economic history shows that most financial crisis recessions tend to be longer with more extreme losses in rare times of severe macro financial stress. These financial crisis recessions further tend to create larger government debt burdens by the end due to lower tax revenue. Hence, financial crises can beget sovereign debt crises. Better bank crisis resolution requires fiscal integration and monetary stimulus.

Fifth, central bankers often learn to maneuver their monetary policy levers such as zero interest rates, quantitative-easing large-scale asset purchases, and lax bank reserve requirements. In response to mild or moderate financial crises, the central bank only has to strategically cut interest rates in order to boost the real economy and capital investment accumulation. The central bank can also trade foreign dollar reserves in order to help stabilize the currency market via flexible exchange rates. In the Global Financial Crisis of 2008-2009, specifically hitting the zero interest rate and a low inflation target, most central banks such as the Federal Reserve System and European Central Bank soon run out of conventional ammunition. Then these central banks would resort to unconventional quantitative-easing large-scale asset purchases in order to restore bank capital and liquidity in the financial system.

Sixth, fiscal policymakers need to introduce countercyclical fiscal deficits and other government expenditures on health care, infrastructure, global trade, finance, and technology in order to bolster the real economy and capital accumulation over time. Across the same trade bloc, some fiscal integration is quite essential for sovereign debt resolution. This fiscal integration can better balance fiscal deficits and inflation risks as the real economy moves from a macro upturn to a severe recession. Fiscal policymakers learn to cap the national debt-to-GDP ratio at some threshold below 90%. This cap helps avoid the negative relation between national debt-to-GDP and real GDP economic growth in global macro history.

Oscar Jorda and his co-authors such as Moritz Schularick and Alan Taylor (2019) empirically analyze the total asset return data from 1870 to 2015. Long-run annual returns hover around 7% for the stock and residential real estate markets. However, the capital gains on bonds and residential properties are relatively low or about 1% per year. In this positive light, there can be substantial diversification benefits when the investor holds different assets in the long run.

Jorda et al (2019) further show that the safe asset return (on both bonds and bills) has declined dramatically to the low and volatile range of 1% to 3% in recent years. This evidence sheds skeptical light on whether Treasury bonds and bills can serve as effective inflation hedges over time. Moreover, the same evidence suggests that the neutral interest rate seems to have fallen significantly in recent decades. Most central banks often learn to delay gratification of short-run interest rate adjustments. In this fundamental sense, the neutral interest rate becomes significantly lower for the real economy to return to full employment with low and stable inflation. In effect, this global mega trend allows the central bank achieve maximum employment and price stability in the dual mandate.

Jorda et al (2019) show that the equity risk premium has somehow become higher from 4%-5% to 6%-8% in recent decades. To help explain the equity risk premium, Barro and Ursua (2008) revisit and then reconstruct historical data on stock market return and total consumption time-series. From the Global Financial Crisis of 2008-2009 to the Great Depression of the 1930s, rare disasters might well help explain the equity risk premium puzzle because very rare draws from a non-Gaussian fat-tail distribution can substantially boost the equity risk premium for reasonable risk aversion parameters of 5 to 10. Recent empirical evidence shows a negative nexus between stock market value and momentum returns. A linear combination of value and momentum stocks can yield much higher average returns and Sharpe ratios. The value-momentum combo persists in the U.S. and non-U.S. financial markets for stocks, bonds, currencies, and commodities.


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Brass Ring International Density Enterprise (BRIDE) © 



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