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September 5, 2013

The Cost of the Financial Crisis

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The Dallas Fed put out a very interesting paper (PDF) in July in which they try to quantify the damage done by the 2007-09 financial crisis. Don’t go looking to this paper to find anything about the “cause” or “roots” of the crisis, or how to get out of it, or whether the right policies were followed, etc. No, they’re just trying to quantify the costs to the economy, which is valid and interesting in itself.

They come up with some astonishingly large numbers. Without going into enormous detail here (you can read the paper yourself if you have an appetite for enormous detail), they find that the cost of the financial crisis is at least 40-90% of a full year’s (2007) economic output for the United States. I say “at least” because, after they have figured in a few other factors they believe are valid, they conclude that “what the U.S. gave up as a result of the crisis is likely greater than the value of one year’s output.”

That’s between $6 trillion and $14 trillion lost, or the equivalent of $50,000 to $120,000 for every U.S. household. Now it seems big.

Like I said, their paper doesn’t go into causes and solutions, but others will, which is the purpose of this blog. Those who worship in the Church of Keynes (I’m thinking Paul Krugman, but of course there are many more) will take evidence like this and say, “See! It would have been completely justified to increase the stimulus by a $trillion if it could have headed off a loss of $14 trillion! A trillion in stimulus spending is a bargain compared to a loss of a full year’s economic output!” So I have some concern that quantifying the size of the loss will, in the minds of Keynesians, justify their calls for much higher stimulus spending.

But, of course, such calls would still rely on their original faith premise, which is that stimulus spending WOULD prevent recession and losses to the economy. And there is no proof of that—in fact, history has pretty much demonstrated the opposite. As far as stimulus records go, attempts to stimulate economic growth through supply-side tax cut policies have been from fairly to enormously successful, while attempts to stimulate growth through borrowing and spending have led us to, well, this mess. And all the Keynesians can do is say that it would have worked if only we had borrowed and spent more, much more.

So it’s interesting to attempt to quantify the losses from the financial crisis, but those huge numbers are the price we paid for the bad policy that caused the crisis and for the even worse policy in attempting to recover from the crisis. They’re not the justification for even more borrowing and spending—unless you’re already in the habit of operating based on faith rather than data.

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