3.31.10 I'm not going to say that Andy Haldane is cherry picking his data...

I do read a little bit here and there and enjoy the occasional building of a model to test a thesis. So when I observed Ryan Avent noting The Bank of England's Andy Haldane on costs of the crisis, my ears perked up. To whit:

[T]hese direct fiscal costs are almost certainly an underestimate of the damage to the wider economy which has resulted from the crisis – the true social costs of crisis. World output in 2009 is expected to have been around 6.5% lower than its counterfactual path in the absence of crisis. In the UK, the equivalent output loss is around 10%. In money terms, that translates into output losses of $4 trillion and £140 billion respectively.

Moreover, some of these GDP losses are expected to persist. Evidence from past crises suggests that crisis-induced output losses are permanent, or at least persistent, in their impact on the level of output if not its growth rate.3 If GDP losses are permanent, the present value cost of crisis will exceed significantly today’s cost.

By way of illustration, Table 1 looks at the present value of output losses for the world and the UK assuming different fractions of the 2009 loss are permanent - 100%, 50% and 25%. It also assumes, somewhat arbitrarily, that future GDP is discounted at a rate of 5% per year and that trend GDP growth is 3%. Present value losses are shown as a fraction of output in 2009. As Table 1 shows, these losses are multiples of the static costs, lying anywhere between one and five times annual GDP. Put in money terms, that is an output loss equivalent to between $60 trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the UK. As Nobel-prize winning physicist Richard Feynman observed, to call these numbers “astronomical” would be to do astronomy a disservice: there are only hundreds of billions of stars in the galaxy. “Economical” might be a better description.

Now, I know if Mr. Haldane is measuring from Peak GDP and assuming trend line growth from there, but he sure SEEMS to be doing so. I pulled the data for GDP by country from here, which goes to up to 2007, and then got the 2008-2010 GDP growth data from here. The data is indexed in 2000 dollars, so my numbers are going to be a bit different from Mr. Haldane's, but we can divine a little about what he did. So I took my peak GDP number for the UK and the 2010 trough number for the UK, assumed that some % of that would not return, took Haldane's 3% future GDP trend growth and 5% discount rate, and calculated the NPV of the difference between the GDP:

Now, of course, my base values are in 2000 dollars rather than 2010 pounds, so its really hard to say if Haldane is measuring from the 2009 peak GDP numbers. But his world GDP numbers are in dollars. Measuring from peak to trough from 2009 to 2010, the same calculation as above gives me the following:


This nowhere near matches Haldane's between 60 trilling to 200 trillion in lost GDP. What if we assume that the world GDP dropped not 1% from 2009-2010, but Haldane's 10% output gap. Now we get the following:

This gets us much closer to Haldane's 60 to 200 trillion number. The other thing we don't know is how quickly the output gap disappears in Haldane's model, which could cause some noise in the data.

So, is Haldane assuming that - peak to trough - world GDP fell by 10%?

This isn't even the biggest flaw in Haldane's thinking. He is stating that this potential 200 trillion loss in GDP justifies more closely regulating the financial sector, that we should have more boring banking. German banking, for example. But maybe there is a tradeoff in growth for having boring banking, that boring banking sacrifices some degree of GDP because it doesn't engender bubbles. Or, as Doug374 noted in the comments for the Economist post:

Strangely, no one ever writes papers about the trillions of dollars in excessive output gains that are made in a booming economy. Irrational exuberance is all deserved gains, while reversion to the mean is seen as the capricious wrath of the gods.

Surely Haldane isn't saying the the UK would have had the exact same growth rate over the business cycle and it was only now that we are seeing the effects of our non-German banking. Indeed, this entire theory of the crisis which Haldane seems to be supporting says that non-boring banking fuels bubbles, that it DOES add something to GDP growth.

So, this leads to the question of is the constrained growth from "boring" banking better or worse than the rapid growth and bust cycles of "non boring" banking? Would the NPV of our current situation be better or worse than a theoretical world where we had "boring" banking?

Since I had the data for GDP for every country, I made a model in which you can select any country in Western Europe plus the US and compare their growth rates from 1969 to 2010.

Then the model compares the GDP rates between the two selections:

Or you can choose a specific period of time to compare:

This allows us plenty of options to choose a "growth modifier" or some degree by which growth would have been reduced because of a boring financial system:


And then we can choose a date to start applying the "Growth Modifier" to historical trend GDP:

So, with our boring banking system in place, we can compare to our current, very "non boring" world. Our model above compares the current UK GDP (from my data) with a hypothetical UK GDP which from 1999 - 2010, was impaired by .89% - or about the difference in GDP growth between the UK and Germany during that time. What do the results show:

Depending on the % of the loss of output which is permanent, having had a boring banking system means that we would a NPV of $3.8 to 6.5 trillion going forward (not to mention whatever GDP would have been lost from 1999-2010).

Of course, it is hard to say how much boring banking effects GDP, and I will leave that to the actual economists, rather than the business students with time and excel on their hands. Rather, the point of this exercise is to try to model the full effects of boring banking across the full business cycle, and to recreate the numbers that Mr. Haldane used. Without him explaining how he got his 200 trillion numbers in more detail, or what effects on GDP growth he'd expect this boring banking to have had, I remain skeptical.

Of course, this same question was posed back in June of 09 by Guillermo Calvo and Rudy Loo-Kung on VoxEU which looked at the data in emerging economies. With probably terrifying amounts of calculus involved behind the scenes, they attempt to answer the question: is the temporary higher growth worth the crash and return to baseline growth?

If anyone would like the excel file I used, or knows a good free service to post the file, feel free to contact me. Or if you get some really interesting insights out of comparing Sweeden to Luxemborg.