« According to macroeconomics textbooks, a fall in aggregate demand
causes a recession in which output drops below potential output – the normal
level of production given the economy’s resources and technology. This effect
is temporary, however. A recession is followed by a recovery period in which
output returns to potential, and potential itself is not affected significantly
by the recession. […]Experience since the financial crisis and Great Recession
of 2008–2009 has strengthened the evidence for long-term effects of recessions.
It has become increasingly clear that the recession has done lasting harm –
that countries around the world face a new normal with lower levels of output
than anyone expected in 2007. In a recent paper (Ball 2014), I seek to quantify
the damage suffered by 23 OECD countries. […]Through what mechanisms do
recessions reduce potential output? This question is addressed in a number of
recent papers (see Ball 2014). While the results vary, it appears that
recessions sharply reduce capital accumulation, have long-term effects on
employment (largely through lower labour force participation), and may slow the
growth of total factor productivity. This last effect is poorly understood –
one possible factor is a decrease in the formation of businesses with new
technologies. A better understanding of hysteresis mechanisms is a high
priority for research. Can policymakers repair the damage from the Great
Recession? Once again, the answer is not clear, but I believe that hysteresis
effects can work in reverse if macroeconomic policy creates a strong economic
expansion. Procyclical investment would increase the capital stock, plentiful
job opportunities would increase workers’ attachment to the labour force, and
so on. My past research finds that expansionary policy can reduce the natural
rate of unemployment (Ball 2009). Today, a strong expansion might push potential
output back toward its pre-crisis path. Failing that, the expansion might at
least reverse declines in the growth rate of potential, so the damage from the
Great Recession does not continue to grow.»( The Great Recession’s
long-term damage Laurence Ball, 1 July 2014, http://www.voxeu.org/article/great-recession-s-long-term-damage)
The reduction of potential output
depends also from expectations. Even if
static expectations can be rational, it is necessary to understand that
rational expectations can be different from static expectations. After a crisis
investors, consumers, policy makers, entrepreneurs can suffer some shock in
expectations. In particular they can reduce their ability to invest in project
and to pursue their own goals. Financial crisis can destroy the ability of
economic operators to realize choices. The compression of rational expectations
reduces the ability to realize choices, to promote projects and this can reduce
the potential growth of the economy.
Even if a crisis destroy common goods, saving, and produce unemployment,
the main destruction generated by a
financial crisis is the reduced ability to
realize rational choices. In effect unemployment can be restored if entrepreneurs
realize new investments, if the policy makers produce new policy devoted to
sustain economic growth, if banks manage credit in the interest of value added production.
But due to the presence of a crisis all
the ability to choose the best way to use economic resources is destroyed. We
can say that the economic crisis breaks the relations among economic operators and by this way
destroy the ability to produce new project, new products, new goods and
services, new firms able to restore the economy. The loss in the relational capital associated to a
reduction in rational choice ability produce a reduction in potential growth.
Even if the capital accumulation is crucial for the determination of the
economic growth, also the ability to realize choices, to have rational
expectations and to accumulate relational capital can sustain potential
economic growth. The growth rate of potential output is related not only on actual
output production,i.e. static
expectations, but also on future output production,i.e. rational expectations.
Future output production depends also by the ability to produce relational
capital able to sustain new investments also reinforcing physical capital.
To restore the potential output
production is necessary to restore the ability of economic operators to realize
rational choices, giving continuity to projects, and giving more attention to
the production of relational capital.
