There is a pleasing myth about the business cycle. This is that it is just a fluctuation around an underlying trend. Output in a boom is above a sustainable level. In a recession it is below it. Budget deficits in the recession phase can be and should be offset by surplus in boom years. Whether you are optimistic or pessimistic about stabilisation policies they exist in a sphere of their own, and economic policy can concentrate on so called “supply side” measures.

Unfortunately, this pretty symmetrical picture is belied by the facts. There is widespread agreement that the damage done in a recession associated with a financial crisis tends to be twice as a severe as one that is not. More important is the finding that much of the loss of output in a severe recession is permanent and that the economy never gets back to its old trend line. This was demonstrated in some detail by the late Christopher Dow in his study, “Major Recessions”, published in 1998. Although that study was rigorous and quantitative it was not in the right key for today's macroeconomists. The latest IMF World Economic Outlook returns, however, to the charge in its fourth chapter, which unfortunately is only obtainable online.

The IMF authors estimate that after a financial crisis output remains 10 per cent below its previous trend in the medium term, which it defines as seven years. This is, of course, an average with wide variations on either side. In Chile after 1981 and Mexico after 1994, output soon rose well above its previous trend while in Japan after 1997 it stagnated for many years. The average estimate may give an exaggerated impression of the enduring loss of productive capacity. It may be influenced by lingering recession effects, which may take more than seven years to disappear. The UK Treasury for example puts the permanent loss of output at 5 per cent of gross domestic product.