June’s worse-than-expected payroll employment numbers have renewed debate about the success of the Obama administration’s economic stimulus plan. The unemployment rate in June was higher than the peak unemployment rate predicted by the administration as recently as January. Does this indicate the administration’s policies are failing? Or does it simply show that the recession is unexpectedly severe and economic forecasting is an inexact science?
For people who do not make their living as economic forecasters, it is hard to make an informed judgment about the forecasts prepared by the administration. Like other observers, I was surprised last winter by the apparent optimism of the administration and Federal Reserve economic forecasts. It seemed to me (and to others) that the severity of the financial crisis and the sharp drop in asset prices signaled the onset of a downturn that would be much worse than average. The potential severity of the recession did not appear to be reflected in the administration’s or the Federal Reserve Board’s short- and medium-term forecasts. In the administration’s January forecast, for example, the peak quarterly unemployment rate, even without an economic stimulus package, was predicted to be 9.0 percent. In the just-completed April-June quarter, the actual unemployment rate averaged 9.2 percent, and it is still rising.
The administration was not alone in publishing a forecast that turned out to be too optimistic. In its January 2009 forecast, the Congressional Budget Office predicted that the unemployment rate would average 8.3 percent in 2009 and 9.0 percent in 2010, assuming no economic stimulus package was passed. As CBO pointed out in that report, its outlook was more pessimistic than that of private forecasting firms. Under the more pessimistic CBO forecast prepared in March 2009, after Congress passed the stimulus package, the annual unemployment rate at the trough of the recession was still predicted to be 9.0 percent, a rate that is one-half percentage point below the 9.5 percent monthly unemployment rate actually recorded in June 2009. The administration and the CBO can defend their winter forecasts by pointing to the predictions of other professional forecasters, few of whom foresaw the severity of the current recession.
As I have noted elsewhere, the optimism of the administration’s winter forecast carried a real political risk. By predicting a milder recession than the one that we actually experienced, the administration may have added fuel to its opponents’ claims that the stimulus package and other administration policies are failing. Voters might wrongly conclude that the shortfall in economic performance is due to the administration’s own policies, including its tax and spending program and its handling of the banking crisis. This view is wrong, I think, because the recession was likely to be worse than predicted by the administration and most private economic forecasters. The depth of the recession is partly explained by serious policy errors, but the errors were committed by an earlier administration, not this one.
In making economic forecasts, an administration faces a tough choice. If its forecast is considerably more pessimistic than the consensus outlook of private forecasters, it can be criticized for trying to take policy credit for economic performance that exceeds its too-pessimistic forecast. If its forecast is too rosy, it can be criticized for understating the future deficits implied by its policies. What matters in the current recession is the identification and adoption of policies that will improve the economic outlook. Are the administration’s policy prescriptions correct? If they are adopted, how much will they affect the economic outlook?
The plain fact is the even the best economic forecaster cannot reliably predict the future course of output, private consumption, or unemployment. Old forecasts therefore provide a very uncertain guide for determining whether an administration’s policies have succeeded or failed. The fact that the economy has turned out to be weaker than predicted in earlier forecasts actually strengthens the case for adopting the counter-cyclical policies proposed by the administration. If the economy continues to deteriorate, it will strengthen the case for another dose of fiscal stimulus as well.