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How We Ended the Great Recession
JULY 27, 2010
Prepared By
Alan S. Blinder
Gordon S. Rentschler Memorial Proessor o Economics, Princeton University609.258.3358blinder@princeton.edu
Mark Zandi
Chie Economist, Moody’s Analytics610.235.5151mark.zandi@moodys.com
HOW WE ENDED THE GREAT RECESSION
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How We Ended the Great Recession
BY ALAN S. BLINDER AND MARK ZANDI
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T
he U.S. government’s response to the nancial crisis and ensuing Great Recession included someo the most aggressive scal and monetary policies in history. The response was multi-aceted andbipartisan, involving the Federal Reserve, Congress, and two administrations. Yet almost every oneo these policy initiatives remains controversial to this day, with critics calling them misguided, ineective,or both. The debate over these policies is crucial because, with the economy still weak, more governmentsupport may be needed, as seen recently in both the extension o unemployment benets and the Fed’sconsideration o urther easing.In this paper, we use the Moody’s Analytics model o the U.S. economy—adjusted to accommodate somerecent nancial-market policies—to simulate the macroeconomic eects o the government’s total policyresponse. We nd that its eects on real GDP, jobs, and infation are huge, and probably averted what couldhave been called Great Depression 2.0. For example, we estimate that, without the government’s response,GDP in 2010 would be about 6½% lower, payroll employment would be less by some 8½ million jobs, andthe nation would now be experiencing defation.When we divide these eects into two components—one attributable to the scal stimulus and the other at-tributable to nancial-market policies such as the TARP, the bank stress tests and the Fed’s quantitative eas-ing—we estimate that the latter were substantially more powerul than the ormer. Nonetheless, the eectso the scal stimulus alone appear very substantial, raising 2010 real GDP by about 2%, holding the unem-ployment rate about 1½ percentage points lower, and adding almost 2.7 million jobs to U.S. payrolls. Theseestimates o the scal impact are broadly consistent with those made by the CBO and the Obama administra-tion.
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To our knowledge, however, our comprehensive estimates o the eects o the nancial-market policiesare the rst o their kind.
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We welcome other eorts to estimate these eects.
HOW WE ENDED THE GREAT RECESSION
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The U.S. economy has made enormousprogress since the dark days o early 2009.Eighteen months ago, the global nancialsystem was on the brink o collapse and theU.S. was suering its worst economic down-turn since the 1930s. Real GDP was allingat about a 6% annual rate, and monthly joblosses averaged close to 750,000. Today,the nancial system is operating much morenormally, real GDP is advancing at a nearly3% pace, and job growth has resumed, albeitat an insucient pace.From the perspective o early 2009, thisrapid snap-back was a surprise. Maybe thecountry and the world were just lucky. But wetake another view: The Great Recession gaveway to recovery as quickly as it did largelybecause o the unprecedented responses bymonetary and scal policymakers.A stunning range o initiatives was un-dertaken by the Federal Reserve, the Bushand Obama administrations, and Congress(see Table 1). While the eectiveness o anyindividual element certainly can be debated,there is little doubt that in total, the policyresponse was highly eective. I policymak-ers had not reacted as aggressively or asquickly as they did, the nancial systemmight still be unsettled, the economy mightstill be shrinking, and the costs to U.S. tax-payers would have been vastly greater.Broadly speaking, the government setout to accomplish two goals: to stabilizethe sickly nancial system and to mitigatethe burgeoning recession, ultimately re-starting economic growth. The rst taskwas made necessary by the nancial crisis,which struck in the summer o 2007 andspiraled into a nancial panic in the all o 2008. Ater the Lehman Brothers bank-ruptcy, liquidity evaporated, credit spreadsballooned, stock prices ell sharply, and astring o major nancial institutions ailed.The second task was made necessary by thedevastating eects o the nancial crisis onthe real economy, which began to contractat an alarming rate ater Lehman.The Federal Reserve took a number o ex-traordinary steps to quell the nancial panic.In late 2007, it established the rst o whatwould eventually become an alphabet soup o new credit acilities designed to provide liquid-ity to nancial institutions and markets.
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TheFed aggressively lowered interest rates during2008, adopting a zero-interest-rate policy by year’s end. It engaged in massive quantitativeeasing in 2009 and early 2010, purchasingTreasury bonds and Fannie Mae and FreddieMac mortgage-backed securities (MBS) tobring down long-term interest rates.The FDIC also worked to stem the nan-cial turmoil by increasing deposit insurancelimits and guaranteeing bank debt. Congressestablished the Troubled Asset Relie Pro-gram (TARP) in October 2008, part o whichwas used by the Treasury to inject much-needed capital into the nation’s banks. TheTreasury and Federal Reserve ordered the 19largest bank holding companies to conductcomprehensive stress tests in the spring o 2009, to determine i they had sucientcapital to withstand urther adverse circum-stances—and to raise more capital i neces-sary. Once the results were made public, thestress tests and subsequent capital raisingrestored condence in the banking system.The eort to end the recession and jump-start the recovery was built around aseries o scal stimulus measures. Tax rebatechecks were mailed to lower- and middle-income households in the spring o 2008;the American Restoration and Recovery Act(ARRA) was passed in early 2009; and sev-eral smaller stimulus measures became lawin late 2009 and early 2010.
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In all, close to$1 trillion, roughly 7 percent o GDP, will bespent on scal stimulus. The stimulus hasdone what it was supposed to do: end theGreat Recession and spur recovery. We donot believe it a coincidence that the turn-around rom recession to recovery occurredlast summer, just as the ARRA was providingits maximum economic benet.Stemming the slide also involved rescuingthe nation’s housing and auto industries. Thehousing bubble and bust were the proximatecauses o the nancial crisis, setting o a vi-cious cycle o alling house prices and surgingoreclosures. Policymakers appear to havebroken this cycle with an array o eorts, in-cluding the Fed’s actions to bring down mort-gage rates, an increase in conorming loanlimits, a dramatic expansion o FHA lending, aseries o tax credits or homebuyers, and theuse o TARP unds to mitigate oreclosures.While the housing market remains troubled,its steepest declines are in the past.The near collapse o the domestic autoindustry in late 2008 also threatened toexacerbate the recession. GM and Chryslereventually went through bankruptcies, butTARP unds were used to make the processrelatively orderly. GM is already on its wayto being a publicly-traded company again.Without nancial help rom the ederalgovernment, all three domestic vehicle pro-ducers and many o their suppliers mighthave had to liquidate many operations, withdevastating eects on the broader economy,and especially on the Midwest.Although the economic pain was severeand the budgetary costs were great, thissounds like a success story.
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Yet nearly allaspects o the government’s response havebeen subjected to intense criticism. The Fed-eral Reserve has been accused o oversteppingits mandate by conducting scal as well asmonetary policy. Critics have attacked eortsto stem the decline in house prices as inap-propriate; claimed that oreclosure mitigationeorts were ineective; and argued that theauto bailout was both unnecessary and unair.Particularly heavy criticism has been aimed atthe TARP and the Recovery Act, both o whichhave become deeply unpopular.The Troubled Asset Relie Program wascontroversial rom its inception. Both theprogram’s $700 billion headline price tag andits goal o “bailing out” nancial institutions—including some o the same institutions thattriggered the panic in the rst place—werehard or citizens and legislators to swallow. Tothis day, many believe the TARP was a costlyailure. In act, TARP has been a substantialsuccess, helping to restore stability to thenancial system and to end the reeall inhousing and auto markets. Its ultimate cost totaxpayers will be a small raction o the head-line $700 billion gure: A number below $100billion seems more likely to us, with the bankbailout component probably turning a prot.
Criticism o the ARRA has also been stri-dent, ocusing on the high price tag, the slowspeed o delivery, and the act that the un-employment rate rose much higher than theAdministration predicted in January 2009.
HOW WE ENDED THE GREAT RECESSION
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