11 years on, and the Great Recession and its aftermath are still a “mystery”

Recently, there have been several attempts at “making sense” of all that happened. For example, Bernanke has tried to answer the question of why the recession was so deep, while Jason Furman/Martin Sandbu try to make sense of the “slow recovery”. Brad DeLong is more encompassing asking, “Was the Great Recession more Damaging than the Great Depression?

What were the views from years ago?

More than seven years ago, when the “recovery” from the “Great Recession” was about to complete two years, many were worried the recovery was “too slow”. For example, Mark Thoma argued, “It’s not the lack of confidence fairy that is holding things back, its lack of demand and that’s the problem we need to fix.”

In response to Thoma and others, Steve Williamson writes Trends, Doom, and Gloom where he argues:

…the next chart shows the path of real GDP from the most recent NBER-dated business cycle peak, relative to the previous two recessions.

What is interesting here is that, given the depth of the recent recession, the negative deviation from a 3.26% growth trend (from the NBER-dated business cycle peak) appears no more persistent than in the recent two recessions. Thus, whatever phenomenon is driving the slow recovery may not be new, and may have nothing to do with the particulars of the financial crisis.

To Williamson, the depth of the recession, the reason it was named “great”, is a “given”! In addition, given it´s a “given”, was just as “persistent” as the previous two recessions. In fact, according to a theory, given the deep drop, the bounce back should have been stronger; the deviation from trend should be less persistent!

Let us examine (and compare) in detail the last three recessions. To the chart reflecting the drop and persistency of RGDP from the trend, I have added the chart showing the behavior of NGDP relative to trend (my gauge of the stance of monetary policy).

Following the 1990/91 recession, RGDP remains persistently below the post-war trend. Given that monetary policy, for the most part, kept NGDP evolving very close to trend, during this period the Fed achieved nominal stability. The RGDP deviation from trend, therefore, relates to real factors. One candidate is the Savings & Loans (S&L) crisis, when, between 1989 and 1995, the Resolution Trust Corporation (RTC) closed or otherwise resolved 747 institutions.

In the second half of the period, the economy experienced a positive supply (productivity) shock. With that, RGDP converges to trend.

The story following the recession of 2001 is very different. The deviation of output from trend is significantly larger than during the 1990/91 recession. That is consistent with the fact that monetary policy, contrary to the previous case, tightened significantly, with NGDP falling markedly below trend.

When monetary policy turns expansionary (recall “forward guidance” in mid-2003), RGDP begins to climb towards trend. That voyage was interrupted by the oil price shock, a negative supply shock that reduces real growth. At the time, there´s a noticeable uptick in core PCE inflation, which rises from 1.6% YoY average in 2001-03 to 2.1% in 2004-06. That is consistent with the prediction of the dynamic aggregate supply-aggregate demand model, according to which a negative supply shock reduces real growth and increases inflation.

Under those circumstances, the best monetary policy can do is to maintain nominal (NGDP) stability. The Fed acted correctly, taking NGDP back to trend so that the frequent “accusations” that monetary policy was “too easy” at the time are misplaced.

If it weren´t for the oil shock, RGDP would likely have followed the dashed line.


The latest episode is in a league by itself. However, maybe Steve Williamson was on to something when he writes, “Thus, whatever phenomenon is driving the slow recovery may not be new, and may have nothing to do with the particulars of the financial crisis.”

Compared to the 2001 recession, the 2007-09 recession experienced a very deep drop in NGDP relative to trend. The fall in RGDP is commensurate. Thereafter, contrary to what happened before, there is no indication that monetary policy attempted to offset the fall. In other words, there was no attempt at recovery. The Fed has kept the economy depressed! Furthermore, real growth has remained “too slow”, in large measure due to the slowness of nominal spending (NGDP) growth.

In short, the Fed bungled and never “owned-up”. So yes, maybe we are “doomed”!


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