The recession was even worse than anyone thought
Aug 5th 2010 | Washington, DC
A YEAR into America’s recovery the view backwards continues to sharpen—and darken. The Commerce Department’s latest GDP figures show an economy that lost momentum in the second quarter of 2010. But they also include revisions to data going back to the beginning of 2007, covering the whole of the recession. And the recession was worse than previously believed.
The second-quarter figures themselves are pretty lacklustre. Growth slowed to a 2.4% annual pace, down from a rate of 3.7% in the first quarter and below expectations. Exports and consumer spending, the two best engines of a self-sustaining recovery, contributed less to growth than in the first three months of the year. In the 12 months since the unofficial nadir of the recession the economy grew just 3.2%. During the equivalent period after the recession of 1981-82, output leapt upwards by 5.6%.
But the data revisions may provide the bigger story. The updates show an economy that was weaker going into the recession than previously believed, and which declined much more steeply in the immediate wake of 2008’s financial crisis (see chart). These changes confirm the recession as the worst of the post-war years. Economic activity now appears to have declined by 4.1% from peak to trough, easily outstripping the 3.7% dip observed in the downturn of 1957-58 (in 1981-82 the drop was just under 3%). The decline in real GDP in 2009 was far and away the worst annual performance since 1946, when America was dismantling its wartime economy.
This clearer image of the recession may help settle some academic disputes. The downturn bolstered the conviction among some economists that GDP was the rougher of the measures of economic activity. Revisions to GDP, they argued, usually move it closer to an income-based economic gauge—Gross Domestic Income, or GDI—which should therefore be considered more accurate. An esoteric debate perhaps, but with real stakes: during the recession, GDI consistently showed a weaker economy than GDP did. Had policymakers focused on the income-based measure, their reaction might have been speedier and better informed.
Other arguments will continue to fester. Concern has grown over a break in the rough historical relationship between output and employment known as Okun’s Law. Unemployment has seemed “too high”, leading some economists to fret that structural barriers to job growth have become a serious problem.
The new revisions solve the puzzle, but only up to the end of the spring of last year. From the third quarter on, the numbers still look out of whack, if less so than before; and, given the current level of growth, the economy is still not producing enough jobs. The updated view may add to fears that long-term unemployment is a significant threat. The longer high levels of unemployment stretch on, the less they can be explained by weak demand.
And then there is the ongoing debate within the Federal Reserve between inflation hawks and those fearing deflation. The revisions, which reveal a larger gap between potential and actual GDP, shift the field in favour of the deflation worriers, who may argue for more accommodative policy at the Fed’s meeting on August 10th.
The new data might reasonably absolve the Democrats of at least some blame for the economy’s continued listlessness. A deeper-than-believed recession helps explain why the first unemployment forecasts by the White House proved too rosy, and why the stimulus plan has failed to bring down the jobless rate. The hole was simply deeper than it appeared. But voters may prove unsympathetic. What has not been altered is the scope of the employment crisis. If the Democratic leadership allowed over-optimistic GDP numbers to distract them from the obvious trouble in the labour markets, then they now have no one but themselves to blame for their party’s long electoral odds.