With November’s election fast approaching, the Republican candidates seeking to challenge President Barack Obama claim that his policies have done nothing to support recovery from the recession that he inherited in January 2009. If anything, they claim, his fiscal stimulus made matters worse.  And, despite recent improvement, the level of unemployment indeed remains far too high.not blame George W. Bush for the recession that began two months after he took office in 2001. There hadn’t yet been time for bad policies to damage the economy.)

Obama’s Democratic defenders counter that his policies staved off a second Great Depression, and that the US economy has been steadily working its way out of a deep hole ever since.  Middle-ground observers, meanwhile, typically conclude that one cannot settle the debate, because one cannot know what would have happened otherwise.

There is a good case to be made that government policies - while not strong enough to return the economy rapidly to health — did indeed halt an accelerating economic decline.    By “government policies,” I mean not just the fiscal stimulus the new president steered through Congress when he took office, but also the Obama version of TARP, and Fed Chairman Ben Bernanke’s aggressive monetary stimulus.   All three policy initiatives remain extremely unpopular with Republicans, and ambiguous among swing voters.

But the middle-ground observers are of course right that one cannot prove what would have happened otherwise.   It is also true that it is rare for a government’s policies to have a major impact on the economy immediately.  These things usually take time.  One cannot infer the merit of a new president’s policies from the path of the economy during his first few months in office.  (For example, I did

But here is the remarkable thing: whether one listens to the Republicans, the Democrats, or the middle-ground observers, one gets the impression that the economic statistics show no discernible improvement around the time that Obama took office. In fact, the reality could hardly be more different.

This is especially true if one looks at revised economic statistics, which show the US economy to have been in far worse shape in January 2009 than was reported at the time. In January 2009, the annualized growth rate in the second half of 2008 was officially estimated to have been negative 2.2%; but current figures reveal it to have been a horrendous negative 6.3%. This is the main reason why the level of economic activity in 2009 and 2010 was so much lower than had been forecast, which in turn explains why unemployment was so much higher.

Figure 1 shows the quarterly economic growth rate. The maximum rate of contraction — a veritable freefall in the economy — came in the last quarter of 2008 (the quarterly GDP data come from the Bureau of Economic Analysis of the U.S. Commerce Department).   More specifically, it came in December, according to the monthly GDP estimates from the highly respected MacroAdvisers.   (See monthly income figures in the form of growth rates in Figure 2 or levels of GDP in Figure 3.)  This was the month before Obama was inaugurated.  The situation miraculously began to improve as soon as Obama’s term began! 

(click here for larger graphs)

The full force of the fiscal stimulus package began to go into effect in the second quarter of 2009.    The NBER officially designates the end of the recession as having come in June of that year.  GDP growth turned positive in the third quarter.

US economic growth slowed down again in late 2010 and early 2011, as one can see in Figure 1.  The timing coincides with the beginning of withdrawal of the Obama fiscal stimulus. Indeed, the government has been the one sector to experience contraction in income and employment over the most recent five quarters.  The private economy has been expanding.

Other economic indicators, such as interest-rate spreads and the rate of job loss, also turned around in early 2009. Labor-market recovery normally lags behind that of GDP - hence the “jobless recoveries” of recent decades. But the graph of monthly job losses and gains reveals that here, too, the end of the freefall came precisely when Obama was inaugurated.  The last two charts show the same “V” shaped pattern in the monthly job change figures that are released by the Bureau of Labor Statistics, as the GDP growth figures that are released by the BEA.  The rate of job growth over the last two years, inadequate as it is, actually exceeds the rate of job growth during the Bush Administration, even if one counts only the period before the big recession hit in December 2007.

Again, these graphs do not demonstrate that Obama’s policies yielded an immediate payoff. In addition to the lags in policies’ effects, many other factors influence the economy every month, making it difficult to disentangle the true causes underlying particular outcomes.

What is the right way to assess whether the fiscal stimulus enacted in January 2009 had a positive impact?   Start with common sense. When the government spends $800 billion on such things as highway construction, teachers and policemen who were about to be laid off, and so on, it has an effect. Workers who would otherwise not have a job now have one. Furthermore, they may spend some of their income on goods and services produced by other people, creating a multiplier effect.

Those who claim that this spending does not boost income and employment (or that it even hurts), apparently believe that as soon as a teacher is laid off, a new job is created somewhere else in the economy, or even that the same teacher finds a new job right away. Neither can be true, not with unemployment so high and the average spell of unemployment much longer than usual.

They also think that the government deficit drives up inflation and interest rates, thereby crowding out other spending by consumers and firms. But interest rates are rock bottom, even lower than they were in January 2009, while core inflation is running at its lowest levels since the early 1960’s. The conditions of the last four years - high unemployment, depressed output, low inflation, and low interest rates - are precisely those for which traditional “Keynesian” remedies were designed.

Economists’ more sophisticated forecasting models also show that the fiscal stimulus had an important positive effect, for much the same reasons as the common-sense approach.   The non-partisan US Congressional Budget Office reports that the 2009 spending increase and tax cuts gave a positive boost to the economy, and indeed had the extra multiplier effects of the traditional Keynesian models. Allowing for a wide range of uncertainty [to allow for different economists' views], the CBO estimates that the stimulus added 1.5 percent to 3.5 percent to the level of GDP by the fourth quarter, relative to where it otherwise would have been.  The boost to 2010 GDP, when the peak effect of the stimulus kicked in, was roughly twice as great.

To be sure, of the many theoretical models produced by eminent macroeconomists at prestigious universities, some say that fiscal stimulus has no positive effect on the economy, even under recent economic conditions.  (The theoretical innovations underlyng the models have even won Nobel Prizes for the innovators, and not without justice.)  But these models are not sufficiently realistic to meet the market test:  they are not used by private businessmen for whom getting good forecasts matters to their planning and in turn to the success of their businesses.

Of course, econometric models do not much interest the public at large. A turnaround needs to be visible to the naked eye to impress voters. Given this, one can only wonder why basic charts, such as the 2008-2009 “V” shape in growth, have not been used - and reused - to make the case.

(Click here for larger versions of all 5 graphs.)

[Appears also at Fair Observer,with a nice presentation of the charts.

A shorter version appeared as an op-ed at Project Syndicate, which has the copyright.]

This morning the Bureau of Economic Analysis released its first estimate for 2011 GDP.   It showed national output for the first time surpassing the pre-recession peak, which occurred in the last quarter of 2007.    (See chart below)    The expansion in 2011 was led by autos, computers, and other manufactured goods.

Given that the economy hit its trough in mid-2009, the long slow climb since then has been disappointing.   The outcome turns out to have been worse than the conventional wisdom that sharp declines tend to be followed by sharp recoveries.   On the other hand, the outcome turns out to have been somewhat better than the Reinhart-Rogoff thesis that when the cause of a recession is a financial crisis, the recovery tends to take many years.  

To be sure, the housing market has yet to recover and households are still painstakingly rebuilding their battered balance sheets.   But is this the complete explanation for the disappointing state of the economy — the origins of the crisis in a housing bubble and financial collapse?   

The first point to note is that the biggest single reason why the level of GDP over the last three years has been lower than most people forecast in January 2009 has nothing to do with overly optimistic forecasts in January 2009 of the rate of growth looking forward, nor with how good or bad Obama’s policy proposals were, nor with how effective the Republicans turned out to be at blocking them.  The BEA subsequently revised the GDP statistics substantially downward, and now reports that the real growth rate of the economy in the last quarter of the Bush Administration, instead of negative 3.8% per annum as reported that January, was in fact negative 8.9% per annum! The trough of the V was far deeper than was realized at the time.

The second point to note is that construction, which usually helps lead the economy out of a recession, remained, indeed had a strong negative influence on GDP throughour 2006-2010.   Fortunately, in the latest figures, residential construction finally returned to a (small) positive source of growth in the economy over the last three quarters.

The third point to note is that the government sector has been the one component of demand to exert a substantial negative effect througout the last five quarters.   The reason is the withdrawal of fiscal stimulus at the federal level, at a time when state and local governments are also cutting back sharply on spending and employment. 

         December 31 is technically the end of the first decade of the 21^st century.  It is perhaps an appropriate time to review one’s predictions.    It seems to me that I got some things right over the last decade.  Indulge me while I review the predictions that came true, before turning to those that did not work out as well.

Stock market peak     At the end of the 1990s, I felt that the dizzying ascent of equity prices could not continue into the new decade, that there was “…a bubble component in the stock market”  (Nov. 20, 1999).   This was four months before the bubble burst in 2000.  So far so good.

The Euro        Also at the start of the decade, I thought the european currency was undervalued.   My prophesy: “… there will be a major appreciation of the euro against the dollar” (June 21, 2000).  Over the next eight years the euro in fact rose 60% in value.    (But ”I don’t mean to express an optimistic forecast regarding European economics or governance…. Europeans have made many mistakes, the leaders and public alike.” 2006.)

TIPS           I recommended Treasury Inflation-Protected Securities to my blog readers, early in what turned out to be a period of steep rise in their value.  (Feb. 2009.)

            The big economic story  of the decade of course was its second recession, the worst in 70 years, and the severe financial crisis that caused it.    A number of economists got important parts of the 2007-09 crisis right ahead of time (although nobody got all of it right).   I give credit in particular to Krugman, Shiller, Gramlich, Rajan, Borio and White at the BIS, Rogoff, and Roubini.  A 2009 paper identifies 12 commentators as having warned that the US housing market would end in a serious recession.

What parts of the crisis did I get right?

Severity of recession             After the tax cuts of 2001 and 2003, I predicted that spending growth and deficits would rise rather than fall, and that the legacy of high debt would mean that the next recession would be longer and more severe than past recessions:

 ”Good economic logic does not support the idea that Bush fiscal policies caused the weak economy of the last three years. Good economic logic supports, rather, a causal link between Bush fiscal policies and the next recession. The future downturn is likely to be far worse than the recent one…They also created long-range uncertainty that makes planning difficult (nobody from either party expects the relevant tax law to remain as it is currently written)… It is impossible to say when the next recession will come. But when it does, it is likely to be worse than the 2001 recession. Why? Precisely because we will enter it at a time when the budget deficit and national debt are already alarmingly high…Thus when the next recession hits, we will not have luxury of being able to cut taxes and increase spending as George II has done. … The resulting pain will make the economic travails of George II’s first term pale in comparison…”  (Oct. 30, 2003.  Also Dec.2003 and Nov.2004).    
That seems to me precisely what has happened.

Budget deficits   At the start of the decade:  “We need to think about using our budget surplus to provide for the retirement of the baby boom generation, not to blow it on a big tax cut” (May 16, 2001).  But of course the Administration chose the latter policy.   Like many others, I continued throughout the decade to warn that fiscal policy was irresponsible.  The “White House forecast of cutting budget deficit in half by 2009 will not be met,” and “Further, the much more serious deterioration will start after 2009.”  (May 24, 2006.)   Indeed.

Market underestimation of risk        I was dubious of the “Great Moderation.”   By 2006, I was warning frequently of serious risks facing the economy, arguing that even though the odds of each sort of possible setback were small in any given year, the cumulative probability that at least one of them would hit the economy over the next couple of years was relatively high.  (May 24, 2006.)  The markets were underestimating this risk:
 ”How can the implied volatility in options prices be so low?  Perhaps investors are judging risk solely from the statistics of recent history, and not from a forward-looking open-eyed consideration of the risks facing the global economy.”  (Nov. 2006.)    “The implicit volatilities in options prices are substantially too low, and will rise.  … market estimates of risk are lower than they should be.  … the market is basing its perception of risk on recent history, not on a forward-looking assessment of the risks facing the US and global economies.    Such risks include further falls in housing or rises in oil, a hard landing for the dollar, and geopolitical risks arising from the Middle East.”   (Jan.12, 2007. And again, May 14, 2007.)     
The VIX (the CBOE index of market-expected volatility) was close to 10 when that was written.  It was to go as high as 80 when the full financial crisis hit in 2008.

The carry trade “should be reversing.” (Jan.12, 2007.)    Market perceptions of risk had “fallen to irrational lows, as reflected in the low interest rates at which governments of developing countries, unqualified American homebuyers and high-risk businesses could borrow money.” (Nov.19, 2007, and Jan. 2008.)   

International crises    When asked “Have financial developments made the International Monetary Fund obsolete?” my answer was “The IMF is by no means obsolete. …. It is foolhardy to think, just because emerging market spreads have been very low recently, that there will be no more crises in the future.”    (March 1, 2007)   I identified Hungary and other Eastern European countries as particularly vulnerable.  (Jan. 2008.)

The coming financial crash       The comments I made at a Cato conference held in November 2006, shortly before the sub-prime mortgage crisis hit in 2007, look good now:

 ”The Greenspan Fed probably erred by providing too much liquidity in 2001-2004….If the Fed erred in keeping interest rates so low so long after the 2001 recession, what cost are we paying? None yet; but dangers lie in the future. It is not that I am especially worried about inflation at the moment. … what cost do I fear might come from the extraordinarily easy monetary policy of 2001-04? As the Bank for International Settlements points out, some of the biggest financial crashes and some of the longest recession periods have followed liquidity-fed booms that never did show up as goods inflation, but rather as asset inflation…”     (In Responding to Crises, Cato Journal, Spring 2007.)

Housing          Of the various asset markets, housing was the area where policy had most clearly gone awry.    I had long thought “that some people were being pushed to buy houses who couldn’t afford it, that (mirabile dictu) there was such a thing as too high a rate of national homeownership, and that the default rate would shoot up as soon as real interest rates rose or house prices stopped rising.”   (March 26, 2007.)    “Many people bought houses they could not afford unless prices continued to rise rapidly or real interest rates remained extraordinarily low, which predictably did not happen.”  (April 28, 2007.)     

The start of the recession     “[A]t the time of writing [Jan. 2008], the United States appeared to be poised on the brink of recession….A coming recession may be more severe and long-lasting than the last one in 2001….”   By May 2008 I had figured out that a recession was indeed probably underway– at a time when some Administration officials were still ruling it out and indeed GDP figures appeared to show positive growth in the first part of that year.   

Banking crisis resolution       When the Obama Administration announced its revised form of the Bush Administration’s Troubled Asset Relief Program, I argued that maybe they actually knew what they were doing and that the plan should be given a chance to work.  (March 23, 2009.)  I felt pretty isolated.  Others attacked the plan, from both left and right.  They expected Tim Geithner’s stress tests to be phony.  The critics were sure that the taxpayer would end up paying hundreds of billions of dollars to bail out the banks.  They wanted either to nationalize the banks or leave everything to the free market.  As things developed, however, financial collapse was averted without nationalization and the banks have since repaid the Treasury with interest.   

The trough      Financial markets stabilized in the first half of 2009.  Turnarounds in the rates of growth and job loss led me to believe in the summer of 2009 that the economy had probably hit bottom by then.   This turns out in fact to have been the case: The record shows that the recession ended that June.

Predictions gone wrong          Needless to say, I got plenty wrong in the decade as well.   For one thing, I kept expecting U.S. long-term interest rates to rise, because of the alarming long-term fiscal profile. Yet the bond market correction never came.   For another thing, based on econometric estimation of reserve currency holdings, Menzie Chinn and I projected that the euro might eventually rival the dollar in international currency use by 2015 or 2022.    It now seems unlikely.   I certainly thought that the sort of financial crisis that began in the U.S. in 2007-08 would be accompanied by a fall in the dollar.  Yet flows into the U.S. showed that the dollar is still a safe haven.  For this reason I abandoned my euro-bullishness, even before the mismanaged Greek crisis in early 2010.

My most spectacularly wrong predictions were all in the area of politics.  I had thought that if any presidential candidate gained the White House without winning the popular vote, his entire term would be consumed by divisive efforts to reform the Electoral College.   (This did not happen after January 2001.)   I had thought that if a high-casualty international terrorist attack hit the U.S. (September 11, 2001), American foreign policy would thereafter become ruled less by jingoism and more by expertise.  (Not!)   In 2008 I suspected that a Democrat who was perceived as a northern liberal could not be elected president.   (Wrong again.)  

In the coming decade, I resolve to eschew political forecasts, and stick to economics.

[Comments can be posted on the Belfer site.]

              The NBER’s Business Cycle Dating Committee, of which I am a member, announced this morning that June 2009 was the trough of the recession that began in December 2007.    It was the longest recession since the 1930s.

              It is the fate of the Committee to be teased mercilessly every time we make one of our formal declarations of a turning point in the economy.   We get it from both directions:    We waited too late to call the end of the recession, or we did it too early.     (Occasionally someone makes both criticisms simultaneously!)   Even The Daily Show got in on the fun this time.

              On the one hand, people say “Who needs the NBER to tell us what we already knew?”    It is true that GDP has been expanding for 5 quarters now, and that most economists have therefore considered the recession over for some time.   But it is not that easy to call the precise trough, for several reasons:  different indicators say different things regarding the precise date of the bottom, data get revised, and we could not have been confident until now that a hypothetical new downturn would count as a second recession instead of a continuation of the first one.    Does the 15-month lag in this announcement seem like a long time?  It took us 18 months to declare the end of the preceding recession (2001).

              On the other hand, people say “It doesn’t feel like the recession is over to me or to people I know.  How can the NBER be so out of touch?”   The main answer, here:  The proposition that the recession is over is only a statement that things are no longer getting worse; it is not a statement that we are back to good times.    The economy still feels bad for good reason:  it is bad.  In particular the unemployment rate is still very high.   But things are much better now than they were 18 months ago, when the economy was in freefall, or in mid-2009, when we were at the bottom of the worst downturn since the Great Depression.  It takes a long time to emerge fully from a hole that deep.  And, to be sure, the current pace of the expansion is disappointingly slow, especially with respect to jobs.  But GDP and employment are, at least, rising.

              The other question that we are asked the most is whether one should worry about a double dip recession.  The NBER does not forecast.  I can speak only for myself.    The possibility of a new downturn is indeed a concern, especially because Washington has been unable to deliver a sensible fiscal response. (A sensible policy in my view would consist of some more stimulus, as in February 2009, designed to maximize bang-for-the-buck, coupled with simultaneous steps to move the long-term fiscal path back toward responsibility, such as social security reform).    But even without an appropriate fiscal response, I am optimistic that we can avoid sliding back into a second outright recession.  More likely, we will have a slow continuation of the current (inadequate) recovery.

The NBER Business Cycle Dating Committee this morning posted an announcement that it had met in person April 8 - an infrequent event - but that it had not yet decided to call the trough in the recession that began in December 2007.    The meeting has led to lots of questions from the press over the weekend, for stories that appeared today, and then more questions today in response to those stories.  Here are some of the questions that have come up the most often, and my own personal answers, speaking for myself and not the Committee of which I am a member. (more…)