Why So Many Economic Forecasters Missed the Great Recession

(Bloomberg Opinion) -- I joined the Monetary Policy Committee at the Bank of England in July 2006. I didn’t apply for the job.

I read in the Financial Times that the U.K. government was looking for a replacement for Professor (now Sir) Steve Nickell, whom I had known for years. I eventually got a call from (now) Lord Nick Macpherson, permanent secretary of the Treasury, asking if I was interested. A couple of weeks later, while on holiday at the Boulders Resort in Arizona, they called to offer me the job.

I served on the MPC from 2006 to 2009. During the second half of that term, from around October 2007 onward, for many months in a row I started to vote for interest rate cuts, mostly on my own.

Believe me, it was the worst time of my life. Eight people on the MPC had the same opinion, and I had a different one, so there were only two opinions. I felt as if I had the weight of the British people on my shoulders. As the famous Liverpool football club battle cry from the Kop End that sang out loudly the other day in the 4-0 defeat of Barcelona, from the old Gerry and the Pacemakers song, “Walk on with hope in your heart and you’ll never walk alone.” 

Some years later, Gordon Brown, who as prime minister was absolutely excellent during the crisis, apologized for appointing me “to that awful job.” I still believe Gordon Brown and Ben Bernanke saved the world.

I commuted to the U.K. every three weeks from my home in New Hampshire. During 2007 and the early part of 2008 I watched as shops started closing in the towns in the Upper Valley — Lebanon, White River Junction, Claremont and Windsor.

The housing market started slowing, and house prices turned downward. The patterns I saw where I lived suddenly started to repeat in the U.K. The pandemic had started to spread. Too few people were watching.

Nouriel Roubini, otherwise known as Dr. Doom, had also spotted that a downturn was coming. Some years later, while we were waiting for delayed flights home from Bahrain after we both gave talks there, he and I commiserated on what had happened and that nobody much had listened to our warnings.

While Rome Burned

Turning points are especially hard for forecasters to spot. When the good times roll, they think they will continue forever, and they are too optimistic when the downturn comes. This is what happened in 2008.

Policymakers in government and central banks missed the big one because economists whose job it is to warn of impending doom failed to do so. The job of volcanologists is to predict when a volcano will erupt. Weathermen are supposed to be able to predict when hurricanes will hit. Macroeconomists are supposed to spot recessions.

It is instructive to examine the economic projections reported by members of the Federal Open Market Committee during 2008. In January 2008 the projections for GDP growth for that year were from 1.3% to 2%. The actual quarter GDP outcomes reported for 2008, after a long series of revisions, were -0.68% for the first quarter, +0.50 for the second quarter, -0.48 for the third quarter and -2.11% for the fourth quarter.

The FOMC missed the big one; the central tendencies had no negatives for 2008. The transcript of the Fed’s meeting on Sept. 16, 2008, when it kept the federal funds rate at 2%, only has a couple of mentions of a recession.

The most notable quote, from Chairman Ben Bernanke, has a hint of something coming: “I think what we saw in the recent labor reports removes any real doubt that we are in a period that will be designated as an official NBER recession. Unemployment rose 1.1 percentage points in four months, which is a relatively rapid rate of increase. The significance of that for our deliberations is, again, that there does seem to be some evidence that, in recession regimes, the dynamics are somewhat more powerful, and we tend to see more negative and correlated innovations in spending equations. So, I think that we are in for a period of quite slow growth.”

The transcript makes clear at the very outset that there was deep trouble on Wall Street: “The markets are continuing to experience very significant stresses this morning, and there are increasing concerns about the insurance company AIG. That is the reason that Vice Chairman Geithner is not attending.”

On Saturday, Sept. 13, 2008, Timothy Geithner, then the president of the New York Fed, called a meeting on the future of Lehman Brothers, which included the possibility of an emergency liquidation of its assets. Lehman filed for Chapter 11 bankruptcy protection on Sept. 15, the day before the FOMC meeting.

Boston Fed president Eric Rosengren told my Dartmouth class “The Financial Crisis of the Noughties” some years later that it would have been possible to rescue Lehman Brothers over the several months after Bear Stearns collapsed in March 2008. By Sept. 15 it was too late. Lehman was already insolvent.

The job of the central bank is to help solvent but illiquid banks, not the insolvent. Clearly opportunities were missed.

I got into big trouble at the start of 2008 when I did an interview with Ashley Seager, at the Guardian, when I said the Monetary Policy Committee was “fiddling while Rome burns.” In testimony to the Treasury Select Committee in the House of Commons that oversees the MPC, I worried on March 28, 2008, about what might happen: “My concern would be one should make sure one is ahead of the curve so that later one is not in a position where something horrible happens, I do not want that to occur. My risks are to the downside and I have concerns that something horrible might come and I do not want that to happen.”

Sadly, something horrible did happen.

Mervyn King, the governor of the Bank of England, made it clear throughout 2007 and 2008 that the U.S. was irrelevant to the U.K. At the Treasury Select Committee on March 28, 2008, at the House of Commons, MP Andrew Love asked King whether he was concerned that U.S. recession might spread to the U.K.

“For us, far more important than the United States in terms of the impact on demand in the U.K. is the impact on the euro area because they have a weight three times larger than the United States in our trade-weighted index, so what happens in the euro area is much more important to us directly than the U.S. economy.”

The governor of the Bank of England had no idea what was going on in the British economy in 2008 as the biggest recession in a hundred years hit. It turned out that when the U.S. sneezed, the U.K. caught pneumonia.

Lord King even said this, sitting two seats from me, on the Sept. 11, 2008, a few days before the failure of Lehman Brothers, at another meeting of the Treasury Select Committee meeting: “I do not think we really know what will happen to unemployment. At least, the Almighty has not vouchsafed to me the path of unemployment data over the next year. He may have done to Danny, but he has not done to me.” The unemployment rate had increased from 5.2% in April 2008 to 6.0% in September 2008 and would reach 7.9% a year later. The right answer was that it was going to go up and by a lot.

It wasn’t just in the U.K. that forecasters were hopeless. The International Monetary Fund, for example, in its October 2008 report forecast world output to grow in 2009 by 3.9%. It didn’t turn out that way. Moises Schwartz, the IMF’s director of the Independent Evaluation Office, later argued that “the IMF’s pre-crisis surveillance mostly identified the right issues but did not foresee the magnitude of the risks that would later become paramount.”

Larry Kudlow, now President Donald Trump’s director of the National Economic Council, called it precisely wrong in December 2007, the month that the U.S. entered recession:

Yesterday’s tremendous ADP jobs report puts the dagger into the very heart of the recession case. The fact is, America is working. Look at how close the reports parallel one another. So here’s my point: Jobs aren’t folding. Jobs aren’t plummeting. Jobs are strengthening. Now I’m not smart enough to know what the jobs number is going to be tomorrow, but you could easily have a blockbuster 200,000 jobs report. I don’t know, it could be 150K, it could be minus 600K, but I highly doubt that, folks. When you see this kind of ADP report, you’ve got a whole new situation. There ain’t no recession.

The same day Kudlow’s comments were published, the official data release from the U.S. Bureau of Labor Statistics showed that the unemployment rate rose from 4.7% to 5%, and that the number of unemployed rose by 474,000. Kudlow was at it again in November 2018, arguing that “the basic economy has reawakened and it’s gonna stay there. I mean, I’m reading some of the weirdest stuff, how a recession is around the corner — nonsense. My personal view, our administration’s view, recession is so far in the distance I can’t see it.” Maybe he is right this time, but maybe he isn’t.

The MPC produced a forecast in August 2008 that I have to admit I signed on to — and the main inflation report that accompanied it never made any mention of recession. I am so embarrassed. A couple of weeks earlier the first, quarter on quarter, estimate of quarterly GDP growth was reported by the British Office of National Statistics for 2008 Q2 of +0.2%. 

I had expected the number to be negative, and a positive, really threw me for a loop. By that point I had started to doubt that I was right. I went home after the meeting in early August with the intention of resigning as I was clearly so wrong.

The MPC’s forecast for quarterly GDP growth in 2008 suggests that it was 90% confident that GDP growth on a year earlier would be in the interval from around 0.5% to just over 5%. The saddest thing is that it predicted that there would be no recession — and no quarters of negative growth. The Inflation Report that contained that forecast didn't even include the word "recession".

GDP data are subject to revision, especially at turning points. It took until May 2009 for the 2008 Q2 estimate to be revised to a negative number and confirm the start of the recession, given that the third quarter was always negative. 

In 2019 Quarterly GDP growth for Q22008 is now estimated (Q on Q) as -0.7. The first estimates for Q3 and Q4 were also revised down a lot – Q3 was revised from -0.5 to -1.6 and Q4 from -1.5 to -2.2 now. GDP fell by 6.3%, peak to trough over the five quarters from Q22008 to Q22009.

It is now apparent that in August 2008 the U.K. had been in recession for several months. 

We didn’t know where we were. We didn’t know where we had been, and we didn’t know where we were going.

Same as now.

(This is the first of two excerpts from “Not Working: Where Have All the Good Jobs Gone?” to be published by Princeton University Press in June.)

To contact the editor responsible for this story: Katy Roberts at kroberts29@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

David G. "Danny" Blanchflower is a professor of economics at Dartmouth College and the author of "Not Working: Where Have All the Good Jobs Gone?" He is a former member of the Bank of England's Monetary Policy Committee and a Bloomberg TV contributing editor.

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