Economic Modeling in the Post Great Recession Era

Preface/Justification

For the entirety of the current economic expansion, outcomes have fallen short of expectations. Overall economic growth has been below perceived potential. Inflation remains persistently below the Fed's 2 percent target, while long-term unemployment remains higher and wage growth lower than anticipated. Why?

For decision makers, the deviation of actual outcomes from expected carries important lessons for how we model the actual economic environment we face rather than an idealized vision of the economic landscape that is often based on a view of the past.

Meanwhile, on the public policy front, neither fiscal nor monetary stimulus has delivered on their promised results in terms of real economic growth and jobs. For decision makers, there appears to be little guidance about the connections between idealized theoretical conditions of the economy and actual results of the current recovery.

Our challenge is to recognize that, as we saw with both the fiscal and monetary stimulus, the estimates of policy effectiveness vastly underweighted the impact of market imperfections at the time—looking at idealized conditions rather than the real economy. Broad verbal claims of economic policy effectiveness were disconnected from formal analysis of the actual economic conditions facing the economy and decision makers at the time. Hence, estimates of both fiscal and monetary multipliers were wildly overstated. Real-world conditions of very high credit and liquidity constraints, ...