CentrePiece Spring 2008
20
Recent research by Nick Bloom – as well as
research of an earlier vintage by Fed
chairman Ben Bernanke – suggests that the
impact of the credit crunch on uncertainty
will lead to an economic slowdown much
worse than we currently anticipate.
Will the
credit crunch
lead to recession?
CentrePiece Spring 2008
21
O
ne of the most striking
effects of the recent
credit crunch is a huge
surge in stock market
volatility. The uncertainty
over the extent of financial damage, the
identity of the next banking casualty and
the unpredictability of the policy response
of central banks and governments have
all led to tremendous instability.
A standard measure of uncertainty –
the ‘implied volatility’ of the S&P100 of
the US stock market, commonly known
as the index of ‘financial fear’ – has
more than doubled since the subprime
crisis first emerged in August 2007. This
jump in uncertainty is of similar
magnitude to those that followed the
Cuban missile crisis, the assassination of
President Kennedy, the Gulf War and the
terrorist attacks of 9/11 (see Figure 1).
But after these earlier ‘shocks’,
volatility spiked and then quickly fell
back. For example, after 9/11, implied
volatility dropped back to baseline levels
within two months. In contrast, the
current levels of implied volatility have
remained stubbornly high for the last
seven months, rising rather than abating
as the crisis continues.
My research shows that even the
temporary surges in uncertainty that
followed previous shocks had very
destructive effects. The average
impact of the 16 shocks plotted in
Figure 1 (before the credit crunch) was
to cut US GDP by 2% over the next six
months (Bloom, 2007).
So the omens for the impact of
the current credit crunch are worrying.
If these earlier temporary spikes in
uncertainty had such a significant effect
on economic activity, the impact of the
current persistent spike in uncertainty is
likely to be far worse. On these numbers,
a recession is almost inevitable.
For a broader historical comparison