BIS Study: Post-Crisis Deleveraging Isn’t Necessarily Bad for Growth

This BIS working paper examines data from 39 financial crises, which—like the current one—were preceded by credit booms. Surprisingly, the major finding is that deleveraging following a crisis doesn’t have to depress growth. Here is the paper’s conclusion:

We find that bank lending to the private sector and economic growth are essentially uncorrelated after those financial crises that were preceded by credit booms. This result is relevant for the major advanced economies recovering from the financial crisis, since the current crisis was also preceded by a credit boom. Our results suggest that the ongoing deleveraging in advanced economies might not be as harmful for the recovery as many fear.

We also find that depreciating real exchange rates are statistically and economically significantly associated with substantially stronger economic growth. This finding on real exchange rates shows that the price channel for external adjustment can contribute to stronger economic activities. Consequently, if crisis hit countries can generate substantial real effective exchange rate depreciation, either via nominal exchange rate depreciation or internal cost adjustments, this could hasten their recovery. However, given the global nature of the current crisis this solution might not be available for all countries at the same time.