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CHAPTER 27How Did Central Bankers Fail to Predict the 2008 Recession?

If you read Michael Lewis's great book (or saw the movie) The Big Short (Norton, 2011), you know that many investors predicted the severe 2008 recession that was primarily caused by a bubble in housing prices. The Government Accounting Office (GAO) estimated that the 2008 financial crisis cost the U.S. economy $22 trillion, or more than $60,000 per person (see www.huffpost.com/entry/financial-crisis-cost-gao_n_2687553). Incredibly, Federal Reserve Chair Ben Bernanke and Treasury Secretary Henry Paulson did not see this economic train wreck coming. On February 14, 2008, the two told the Senate Banking Committee that they predicted for 2008 1.8% growth in the U.S. GNP. The President's Council of Economic Advisers was more optimistic, predicting 2.7% GNP growth for 2008 (see money.cnn.com/2008/02/14/news/economy/bernanke_paulson/index.htm).

Lehmann Brothers filed for bankruptcy on September 15, 2008, and the economy's deep descent accelerated. Incredibly, as stated on page 6 of the Fed's minutes from a September 16, 2008 meeting (see www.federalreserve.gov/monetarypolicy/files/fomcminutes20080916.pdf), the Fed stated, “The staff continued to expect that real GDP would advance slowly in the fourth quarter of 2008, and at a faster rate in 2009.”

In this chapter, we will discuss three data-driven techniques that would have predicted a severe economic downturn:

• The yield curve was inverted (see www.nytimes.com/2019/11/08/business/yield-curve-recession-indicator.html ...