Why the Experts Missed the Recession

“There Will Be Growth in the Spring”: How Well Do Economists Predict Turning Points?

by Hites Ahir and Prakash Loungani
Vox, April 14, 2014

Facts and Challenges from the Great Recession for Forecasting and Macroeconomic Modeling

by Serena Ng and Jonathan H. Wright
National Bureau of Economic Research, Working Paper 19469, available at nber.org/papers/w19469
Janet Yellen
Janet Yellen; drawing by James Ferguson

The interest rate policies for the US are set in secret by the Federal Open Market Committee (FOMC) at regularly scheduled meetings eight times a year. Occasionally, the chairman of the FOMC, who is also the chairman of the central bank, the Federal Reserve, holds emergency conference calls as well. The decisions of the committee are briefly reported the next day and only a cursory summary of the minutes of the meetings are published a few weeks later. But a full transcript of the forecast and discussions is not published for five years. Earlier this year, the Fed published the staff’s economic forecasts and the full transcripts of the meetings during the crisis of 2008. The result is a fascinating and disturbing account of how respected experts got things wrong.

By lowering the target rate of interest, known as the federal funds rate, the members of the FOMC can stimulate economic growth, and by raising it, they can dampen growth and inflation. Such Federal Reserve activity, which is accomplished, for the most part, by buying and selling federal securities, has been the dominant policy instrument for controlling the pace of economic growth and inflation in the US since the 1980s.

The year 2008 was momentous economically, and the published proceedings show one of the nation’s most important policymaking bodies operating mostly in the dark about the impending crisis. America and Europe suffered the worst recession since the Great Depression of the 1930s. Unemployment in the US soared to 10 percent, and in some European nations to 25 percent, and millions here and abroad lost their homes. The newly published record shows an extremely limited state of economic knowledge and forecasting ability on the part of committee members. It also shows how undependable attempts to adjust the economy in the short term can be.

Like most economists, the Fed policymaking committee not only failed to anticipate the severity of the Great Recession, it was unaware even that the moderate recession that began in 2007 was underway until it was nearly one year old. “The Fed’s inability to forecast…is disconcerting,” wrote one commentator on the record. But many studies have shown that neither government nor private economists can forecast the economy with any consistency. While they often anticipate the direction of the economy, such forecasts have only limited success because the economy is growing 80 percent of the time. Predictions about when it will stop growing are almost universally inaccurate. Among the studies of the general forecasting record of economists, one of the broadest was recently undertaken by Hites Ahir and Prakash Loungani, both of the International Monetary Fund. They found that, based on a survey of forecasts in many different countries, not one official or private forecast in 2008 anticipated a recession in 2009. Yet there were recessions in forty-nine countries that year.

A recession is defined as a prolonged decline in national income…

This is exclusive content for subscribers only.
Get unlimited access to The New York Review for just $1 an issue!

View Offer

Continue reading this article, and thousands more from our archive, for the low introductory rate of just $1 an issue. Choose a Print, Digital, or All Access subscription.

If you are already a subscriber, please be sure you are logged in to your nybooks.com account.