Opinion, Berkeley Blogs

Class of 1957-Garff B. Wilson Professor of Economics Christina Romer on why the recession was so large

By Brad DeLong

Another long and very interesting quotation from Class of 1957-Garff B. Wilson Professor of Economics Christina Romer's final speech as a cabinet-rank member of the Obama administration, at the National Press Club on September 1, 2010:

This passage explains why our current recession is so much worse and dire than any other post-World War II recession has been.

Class of 1957-Garff B. Wilson Professor of Economics Christina D. Romer:

The current recession has been fundamentally different from other postwar recessions. This is not my fathers recession. Rather than being caused by deliberate monetary policy actions, it began with interest rates at low levels. It is a recession born of regulatory failures and unsound practices that contributed to a housing bubble and eventually a full-fledged financial crisis. Precisely what has made it so terrifying and so difficult to cure is that we have been in largely uncharted territory. An all-out financial meltdown in the worlds largest economy and the center of the worlds financial system is something the world has experienced only once in the past century -- in the 1930s. Thus, the President took office in the midst of a recession of historic proportions, but for which history provided little guidance....

[E]ven before the collapse of Lehman Brothers in September 2008, the U.S. economy had lost over a million and a half jobs and GDP had fallen by more than the average in the previous two recessions. But the worst was yet to come. By the fall of 2008, investors had woken up to the now-obvious reality that slicing and dicing mortgages into mortgage-backed securities and other instruments didnt reduce the aggregate risk associated with investment in housing. As declines in house prices accelerated, fears about the solvency of firms holding mortgage-backed securities set off a genuine financial panic. The collapse of Lehman sent credit spreads skyrocketing and credit availability plummeting. Had the Federal Reserve not responded as rapidly and creatively as it did, the crisis would have been catastrophic. As it was, it was as severe as anything we have experienced since the Great Depression.

Though it was clear that the strain on our financial markets was intense, what was not clear at the time was how quickly and strongly the financial crisis would affect the economy. Precisely because such severe financial shocks have been rare, there were no reliable estimates of the likely impact. To this day, economists dont fully understand why firms cut production as much as they did, and why they cut labor so much more than they normally would, given the decline in output.... Even our statistical agencies appear to have been surprised. The advance estimate of GDP growth in the fourth quarter of 2008 was a decline of 3.8 percent (at an annual rate). The most recent estimate is nearly double that, a drop of 6.8 percent. Likewise, the first estimates of job losses in the last five months of 2008 turned out to be more than a million jobs smaller than the final estimates. The other development that few anticipated was the degree to which the recession would be worldwide....

Despite the fact that we were in uncharted territory, the new economics team back in December 2008 was painfully aware that the economy was facing a terrible downturn and that we were fast approaching the edge of a cliff. At a meeting we had with the President-Elect in Chicago in mid-December, I began by saying: The economy is very weak and deteriorating fast. The weekend before the meeting, the team had sent a memo to Rahm Emanuel echoing this sentiment and laying the groundwork for a larger stimulus package. Whereas most analysts and Congressional policymakers had been contemplating a stimulus of $500 billion or less, we urged that it grow substantially because of the severity of the downturn...