Simon Wren-Lewis provided an excellent description of the stages of recovery from recession. He examined the recovery in the UK and commented on how government policies affected the recovery. His analysis also applies to recoveries in the US and the EZ.
The most recent recessions in the UK (also in the US) were created by the central banks in order to correct for rising inflation. The recessions were easily ended by the central banks by reversing monetary policies to stimulate economic activity. The Great Recession, with the exception of Greece, was different. It was created by the banking system. The banks made bad loans that could not be easily paid back and the credit system collapsed.
The recovery from the collapse of the credit system was made worse by economic policies in the UK and elsewhere. Governments decided that budget deficits, which ordinarily increase during recessions, due to lower tax revenue and increased social welfare spending, should be reduced. They raised taxes and cut government spending. GDP growth in the UK has been reduced 1.5% annually since 2010 and the European Commission estimates that GDP growth in the EZ has been lowered by 4.5% as the result of austerity measures. This contrasts with the rate of growth in typical recessions which usually accelerates in the second stage of recovery.
In the third stage of recovery, the economy grows faster than trend in order to make up for lost ground. That has not happened in the UK. Employment has held up better than output and that is not a good sign. It means that productivity is lower and so are living standards that depend upon growth in productivity. If the lower rate of productivity growth in the UK is permanent, it means that living standards in UK will remain depressed. Its not easy to determine the reason for lower productivity growth but it may be due to the misallocation of credit by the banking system. That leads us back to the problems in banking system.
Bankers believe that they deserve the large share of income that they receive because they provide the money that lubricates the industrial system. The CEO of Goldman Sachs echoed that sentiment by claiming that the banks do God's work. Simon Wren-Lewis disagrees. He believes that rent seeking is responsible for the rising share of income the gravitates toward the financial system. The banks were creating bad products that were sold to poorly informed investors, and they were taking risks to increase profits with the knowledge that they would be bailed out by the government. They were weakened by the financial crisis and they are not providing credit to higher risk start-ups that may be more productive than the more stable large corporations that they support with credit. The decline in productivity may be partially explained by the misallocation of credit. The banks are not doing God's work by allocating credit to its most productive use.
Lewis ends his post on a pessimistic note. He believes that the banks in the UK have too much influence over government policy. The UK government does not support efforts in Europe that might make the banks less profitable. The growth of the financial system is a critical part of industrial policy in the UK. This is also true in the US.
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