The determinants of crisis duration: why did it take Europe so much longer to recover from the Great Recession?

The financial crisis that started in 2007 hit both sides of the Atlantic Ocean very hard. However, where the United States recovered quite quickly, it took Europe almost twice as long to get back to their pre-crisis GDP level. This raises the question what might explain this difference in crisis duration. This paper therefore studies the determinants of crisis duration using a relatively new methodology. Most literature on crisis duration and its determinants estimates the effect on the probability of exiting the recession next period. The new methodology in this paper uses the actual duration in months to see if this yields different results. Among the potential determinants are financial variables (credit growth, credit availability, equity prices and housing prices), labour market rigidity, room for policy intervention (measured by fiscal deficit or public debt), fiscal policy (measured by government consumption) and monetary policy (measured by interest rates or money supply). The estimation of a regression model with panel data of 23 European countries and the United States from 1960 to 2016 shows that the extent of a credit boom and monetary policy are important determinants of crisis duration when duration is measured by the actual duration in months. However, in the probability method, the probability of being in a crisis next period is almost entirely explained by whether a country is in a crisis this period. This big difference in results shows that the two methods of measuring crisis duration are not necessarily the same and that it is important to also consider the ‘new’ duration method.