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August 06, 2009

Every recovery is the same; each recovery is different

Two weeks ago, macroblog looked at the rather pessimistic expectations for what the economic recovery might look like this time around. Included was part of the narrative noting that structural adjustments are likely to impede a quick snapback in gross domestic product (GDP) over the coming quarters.

Macroblog reader Bryan Lassiter asked, "Do economists typically predict a weaker recovery than history suggests?" Good question. To state the question in a slightly different way, "Has the United States ever been in a situation where it experienced a deep recession and forecasters subsequently predicted a slow recovery that ultimately proved to be incorrectly pessimistic?"

To get at these questions, we can look at real-time real GDP data and the Survey of Professional Forecasters (SPF) available from the Federal Reserve Bank of Philadelphia (while the SPF started in 1968, forecasts of real GDP began in 1981).


The chart plots the depth of the recession on the x axis and strength of recovery on the y axis (updated from the 7/24 post to include last Friday's GDP release). The blue diamonds were constructed using forecasts that were made in the quarter the recession officially ended; the red squares are what actually happened.

To illustrate the exercise, pretend we're back in the fourth quarter of 2001 and the recession is over (although we didn't know it). Given what we thought we knew about the economy at the time, we can look at what forecasters were expecting in terms of GDP and compare it with what was ultimately reported by the U.S. Bureau of Economic Analysis. Looking at the 2001 recession, we can see that the expectations for recovery were not that far off, but the severity of the recession was lessened—partly because of data revisions and partly because of forecast error. The 1990–91 recession showed a similar pattern, but in reverse. That is, the recovery forecasts were close to the actual experience, but the depth of the recession ended up being more severe than initially thought.

What stands out in the chart is the recovery following the 1981–82 recession. In real time, four-quarter GDP growth was expected to be about 3.5 percent but wound up being much stronger at nearly 8 percent. In this instance, the response is yes to the initial question of whether economists typically predict a weaker recovery. With the 1981–82 episode, we saw a recession where economists had forecast a recovery that ultimately turned out to be much stronger than anticipated. However, the 1981–82 blue diamond was still relatively close to the cluster of other recessions on the chart, meaning the recovery forecast was not exceptionally weak. Thus, the current recession still seems to be an outlier. Given the almost 4 percent decline experienced in GDP, the hope would be to see something stronger than the 2.5 percent growth expected over the next year.

Whatever the impediments to a sharp recovery, forecasts are certainly telling us that economists are treating this recession as being different from previous ones.

To help track the economy going forward, check out our weekly Economic Highlights and Financial Highlights.

By Mike Hammill, economic policy analyst at the Atlanta Fed

August 6, 2009 in Business Cycles , Economic Growth and Development , Forecasts | Permalink


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But if I understand the graph correctly, I think there's a bit of sample selection bias. You are only considering data points where we know ex post that the recession ended and recovery started on that date. The forecasters didn't know that.

Take a simple example: suppose GDP follows a random walk, with a 50% chance of an increase and a 50% chance of a decrease. The rational forecast will always be for no change. But if we only look at data points where recession ended, we will always see positive growth. So forecasters will always appear to have underestimated the speed of a recovery.

We are comparing: the unconditional forecast of the speed of recovery; with the actual speed of recovery, conditional on recovery happening.

Posted by: Nick Rowe | August 07, 2009 at 08:19 AM

If the forecasts were always the correct direction but only 50% of the right size, you'd conclude that the forecasters were simply too timid, and just double the published forecast.

Alas, recoveries are called too early, leading to the magnitude of a recovery being larger than forecast, but the growth from the point of forecast until the recovery mark being more accurate, even though the short-term forecast was probably the wrong direction.

It seems this counting method is almost designed to give too few data points to analysis. Why not look at the typical 1-year-ahead forecasts, and see how much of all the turns -- both positive and negative -- are captured? With more observations, and fewer issues about selectivity, one could better see that predicting the future much different than the trend is furiously difficult and fraught with error.

And we're not even into the potential biases from the usage of these forecasts. We might debate whether it's more of a problem for society -- for investors, policy-makers, businesspeople -- to have a too-optistic or too-pessimistic outlook. Since part of forecasts for a long time has been cheerleading, and consumer confidence is endogenous here, we can expect lots of well-intentioned happy talk, just like we heard going into the recession.

Posted by: Walt French | August 07, 2009 at 06:58 PM

Nick - I kind of think that’s the whole point of looking at “real time”. To see forecasters’ behavior at the end of a recession with the information they had available to them. They might have had a hunch it was over, but were uncertain about it (sound familiar?). GDP doesn’t follow a random walk with a 50-50 chance of going up or down. It tends to go up more than down - remember productivity, labor & capital? I agree that GDP goes up after a recession ends - the question is by how much and how fast. And, if the economists are way off this time around.

Posted by: jb | August 10, 2009 at 09:31 AM

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