I Hope They’re Right: The Forecast in the 2009 ERP

The Bush Administration’s last Economic Report of the President [large pdf] was released on Friday. From Chapter 1:

The Administration’s forecast calls for real GDP to continue to fall in the first half of 2009, with the major declines projected to be concentrated in the fourth quarter of 2008 and the first quarter of 2009. An active monetary policy and Treasury’s injection of assets into financial institutions are expected to ease financial stress and to lead to a rebound in the interest-sensitive sectors of the economy in the second half of 2009.

Part of the Bush CEA’s optimism (relative to other forecasts [1], [2]) is based upon this correlation:recreg1.jpgChart 1-9: From Economic Report of the President, 2009 Chapter 1 pdf.The regression suggests that if the decline in output is severe, then the rebound will be strong. If, on the other hand as indicated in some forecasts, [3], the peak-to-trough decline in output is 2%, then the rebound will be right about on mean value of 4.6% for two years (in other words, we’re right on the dashed lines in the chart).My one observation is that the last two recession observations (’90-’91; ’01) are substantially below the regression line. One aspect of the 1990-91 recession that seems particularly relevant is the fact that it was accompanied by a capital crunch — that is a crisis that required injections of capital into the banks. In that sense, that recession was conjoined with a financial crisis and a housing crash (see IMF analysis discussed here). So, while I’m hopeful, I’m not too sanguine [4].

Originally published at Econbrowser and reproduced here with the author’s permission.