What Economists Got Wrong About the Great Recession

What do we know, and not know, about macroeconomics? My co-author and I are currently revising our economics textbook — one of our decisions is to emphasize the Great Recession and the pandemic over the Great Depression — so I might be expected to have an answer to this question. Instead, standing on one foot, I would like to offer a short primer to guide us through future crises and downturns.

Let’s start with what we don’t know.

Economists do not, in general, know when business downturns will arrive. If there were reliable signals of a coming downturn, it would arrive immediately, as market actors would contract their plans accordingly, in the expectation of bad times to come. In that sense, there is not much of a predictive window to experience.

That is not a failing of any particular economic theory. Rather, economics as a whole has figured out that expectations are so crucial that business cycles are intrinsically difficult to predict.

Another thing we economists do not always know: is which theory will apply when. Consider the recent experience with what has been called the “immaculate disinflation.”

Some economists, using aggregate demand models, expected that lowering inflation rates from 9% to between 2% and 4% would bring about a recession. While such a recession may yet happen, there is not much evidence of one so far.