On the cost of financial crises

Are financial crises costly? To answer this question, one should not look at the cost of a bailout, a drop in GDP or missing tax revenue, but at what people care about: consumption. In this regard, the current crisis is too young to be analyzed, but other ones are available. Two recent papers look at this for Japan and Norway.

Yasuyuki Sawada, Kazumitsu Nawata, Masako Ii and Mark Lee use panel data from Japan that spans over the 1997 banking crisis and estimate Euler equation that allow for credit constraints. While in normal times, 7.82% of households are credit constraint, this increases only to 8.44% during the credit crunch. In other words, the ability for households to smooth out consumption was only negligibly affected.

Eilev Jansen studies Norway, but prefers a VAR approach linking current wealth and income to consumption, which appears to work better than Euler equation approaches for the recent years. But again, the impact of the crisis on consumption is negligible: the elasticity of equity income on consumption is 2%.

Thus, the impact on consumption seems to be minimal. So why again are we seeing these huge interventions?