2008 Was Much Worse Than We Knew

As everyone now knows, the unemployment rate is far higher than President Obama predicted it would be when selling the country on the American Recovery and Reinvestment Act. That basic mismatch between prediction and results has badly undermined the credibility of the whole concept. But as Ryan Avent points out, the main cause of the mismatch is actually that the economy had already declined much more than was known at the time ARRA was being put together.

Specifically, when Barack Obama took office in the first quarter of 2009, the BEA was saying that the economy contracted 0.5 percent in the third quarter of 2008 and 3.8 percent in the fourth quarter. In fact, we now know that it plunged 3.7 percent and 8.9 percent. This is a huge error. Imaging making the same error in the opposite direction. That would be the BEA describing a major economic boom as a serious recession. Instead they mistook a cataclysmic collapse for a mere serious recession. And this recession happened before Obama took office, meaning that he was faced with a much larger output gap than he realized. Consequently, he framed a policy response that was inappropriate to the actual severity of the situation.

This is important to understanding the politics and economics of the present day. And it also raises important questions for discretionary fiscal policy going forward. After all, if the BEA can’t correctly identify serious downturns, then policymakers can’t correctly respond to them on a discretionary basis. You need to build more automaticity into the system.