------------ EH.NET BOOK REVIEW --------------
Published by EH.NET (April 2010)

Carmen M. Reinhart and Kenneth S. Rogoff, _This Time is Different:
Eight Centuries of Financial Folly_.  Princeton, NJ: Princeton
University Press, 2009.  xlv + 463 pp. $35 (hardcover), ISBN:
978-0-691-14216-6.

Reviewed for EH.NET by Richard Sylla, Department of Economics, Stern
School of Business, New York University.


For financial economists and historians this is a welcome, timely, and
seminal book.  It is welcome because it fills a gap in the literature
of financial crises.  Earlier work is of two kinds, episodic and
analytic in a non-quantitative way.  The episodic approach -- literary
and sometimes flowery accounts of major historical financial crises --
began with McKay (1852) and continued down to Chancellor (1999), and
also includes many studies of individual crises.  The analytic,
non-quantitative approach, describing and analyzing the typical
pattern of a financial crisis and illustrating it with historical
examples, is best exemplified by Kindleberger (1978, with several
later updated editions).  Missing until Reinhart and Rogoff filled the
gap was a thorough study of the quantitative aspects of various
categories of financial crises -- inflation crises, currency crashes
and debasements, external sovereign debt defaults, domestic debt
defaults, and banking crises.  Their quantitative analysis is based on
a huge database covering sixty-six countries that recently accounted
for some ninety percent of world economic product.  Most of the
database is drawn from the past century or two, but some of the
inflation, debasement, and external sovereign debt default evidence
goes back six to eight hundred years.

The book is timely because it provides an extended account -- about a
quarter of the text -- of the financial crisis of 2007-2009, showing
that it has many of the characteristics of previous crises. This
account can be read separately from the rest of the book, for in it
the authors repeat the main quantitative findings from their treatment
of all the previous crises they identify.  Reinhart and Rogoff
demonstrate that, despite the Great Moderation, the sophistication of
modern finance, and the skill of today’s central bankers and other
economic policy makers, this time was not different.  That lesson,
obliquely conveyed in the book’s title, and the lucky timing of its
appearance have given it a widespread popularity in the media -- a
popularity rather unusual for a volume full of tables, charts, and a
hundred pages of appendices describing the data.  Some may find it too
scholarly and a somewhat dry study, and I would surmise that once many
of its purchasers put it down, they won’t be able to pick it up again.
 I had the opposite reaction.  I couldn’t put it down until I had gone
all the way through it, and then I immediately ordered it as an
assigned text for my Spring 2010 MBA course, “The Development of
Financial Institutions and Markets.”  My students are finding it
useful and engaging.

The book should prove seminal because the valuable database on which
it is based will attract the interest of quantitative analysts as ants
are drawn to honey, and because, as Reinhart and Rogoff more or less
admit, they are making a first pass at the data, raising as many
unanswered questions as answers.  Their findings are mostly central
tendencies, i.e., means and medians.  Not much information is
presented on the dispersions of the data around these means, an
obvious avenue to explore in future research.  Nor is there much
detail on any particular crisis -- this, of course, is the bread and
butter of the episodic approach to crisis studies. Moreover, there is
little theory in the book, so theorists will be attracted to its
findings in order to explain why the quantitative facts are what they
are, and to explain the cause-effect relationships that facts have
with one another.

What are some of the key findings?  A selection might include:
1.      From 1340, when England defaulted and ruined prominent Italian
bankers, to 1799, there were nineteen instances of external debt
default. From 1800 to 1945, there were 127 episodes of external debt
default with a median of six years from default to resolution by means
of restructuring, repayment, or debt forgiveness.  From 1946 to 2008,
there were 169 such episodes with a median of three years from default
to resolution.  Defaults often follow spikes in capital inflows.

2.      Although domestic (as contrasted with external) debt defaults
are little studied, domestic debt averages two-thirds of total public
debt.  There are at least 70 instances of domestic default since 1800.
Domestic defaults involve forced conversions to lower interest rates,
reductions of principal, suspension of debt-service payments, and, of
course, inflations that erode the real value of domestic debts.
Output declines an average of eight percent in the three years before
default, and inflation averages 170 percent in the year of default and
remains above 100 percent in subsequent years. Governments are far
from transparent in accounting for their domestic debts, hiding many
of them in off-budget guarantees -- think, for example, of the
unfunded Social Security and Medicare liabilities of the U.S.
government.

3.      Although a few countries have avoided debt defaults
altogether, and others appear to have graduated from repeated defaults
long ago to the avoidance of default for decades or centuries, no
country has been able to escape from having banking crises.  World
financial centers have had numerous banking crises since 1800: the UK
12, the U.S. 13, and France 15.  Banking crises lead to decreases in
tax revenues and increases in public spending, so on average real
government debt increases an average of 86 percent during the three
years following a banking crisis. Costs of bailing out financial
institutions are but a part of this increase. Banking crises are more
usual in periods of high international capital mobility.  Real house
prices and equity prices tend to boom just before a crisis, and then
fall for several years starting with the crisis year.  On average real
house prices decline 35 percent over six years, and equity prices
decline 56 percent over three and one half years.

4.      Moneys around the world have been debased rather continuously
for six or seven centuries. Episodes featuring a stable value of money
for any lengthy period of time are few.

5.      By 2006-2007, the U.S. and a few other countries exhibited
several leading indicators of imminent financial crises: massive
borrowing from other countries, asset price inflation (especially in
real estate), rising household leverage, soaring profits of highly
levered financial firms, and a slowing of output growth.  A number of
academic observers warned of a crisis about to happen; others put
forward “not to worry” analyses and soothing prognostications, as did
leading policy makers. So opinions differed. But it could hardly be
said that since the crisis was inherently unpredictable, the best
course of action for policy makers was to wait until it happened and
then act to contain the damage.

Reinhart and Rogoff, however, say little about what policy makers
should do when the tell-tale signs of an imminent crisis are flashing.
 It’s a difficult problem. Were policy makers to act in a way that
prevented a crisis from happening, they might well be accused of
overreacting to a problem that did not exist, and of needlessly
reducing economic growth -- not to mention stanching the rise of house
and equity prices, and putting the kibosh on the bonuses of bankers --
for no obvious and good reason. What policy maker or politician would
want to run that risk?  Must crises continue to happen because it is
in no one’s ex ante interest to prevent them from happening?

Taking away the punch bowl just when the party is getting good is a
thankless task.  It may, however, be a needed task if we are to
mitigate or avoid the crisis carnage so amply documented in _This Time
Is Different_.  By documenting quantitatively the warning signs and
the negative consequences of financial crises, Reinhart and Rogoff
have made a substantial contribution.  Their work and the further work
it will undoubtedly inspire could give some momentum to reforms that
would reduce both the incidence of crises and the damage that results
from them.  Were that to happen, maybe the next time will be
different.

References:

Edward Chancellor (1999), _Devil Take the Hindmost: A History of
Financial Speculation_. New York: Farrar Straus Giroux.

Charles P. Kindleberger (1978), _Manias, Panics, and Crashes: A
History of Financial Crises_.  New York: Basic Books.

Charles McKay (1852), _Memoirs of Extraordinary Popular Delusions and
the Madness of Crowds_.  Reprint ed., Boston: L. C. Page, 1932.


Richard Sylla is Henry Kaufman Professor of the History of Financial
Institutions and Markets, and Professor of Economics, Stern School of
Business, New York University, and Research Associate, NBER.  With
Douglas Irwin, he is co-editor and a contributor to _Founding Choices:
American Economic Policy in the 1790s_, forthcoming in 2010 from the
University of Chicago Press.

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