It’s not fair to expect Mr. Obama’s economists to be clairvoyant. But they did make one avoidable mistake that led directly to their overoptimism. They relied on the same forecasting models that had completely failed to see the crisis coming.
These models, which are also used by Wall Street and various research firms, do a decent job most of the time. But they are notoriously bad at forecasting turning points because they are based on an assumption that the recent past will more or less repeat itself.
Clearly, recent economic history is not going to repeat itself. It included two huge asset bubbles, first in stocks and then in real estate. The models came to treat those bubbles — and the additional consumer spending they caused — as the new normal. When asset prices began falling, the models couldn’t keep up, with either the pace of declines or the economic damage they were causing.
“All sorts of relationships got completely out of whack, and models couldn’t cope with that,” says Joshua Shapiro, an economist at MFR, a research firm. MFR did not take the models too literally and was one of the few firms to have been appropriately pessimistic. The Obama administration believed the models.
I guess the problem is that, even if you know the crisis has scrambled traditional forecasting relationships, you have very little idea what the new relationships are going to be. So just ditching the old model only gets you so far.