1fAWAwx

ecause of rapidly declining stock and house prices. This was much larger
than the initial decline in wealth at the outset of the Great Depression.2
Falling asset prices reduced the value of collateral and further restricted
the availability of credit and, as credit dried up, many small businesses and
even some large, well-known corporations reported trouble meeting basic
expenses such as payroll. Faced with extraordinary uncertainty about the
economic future, businesses stopped hiring, laid off workers, and shelved
investment plans. As housing and financial wealth plummeted and concerns
over job security mounted, consumers cut back on spending. The effect was
immediate and drastic: in the fourth quarter of 2008, personal consumption
expenditures fell by nearly 5 percent and private investment shrunk 31
percent at an annual rate.
Most economic forecasters underestimated the magnitude of the toll
these shocks would take on the economy, in large part because the United
States had not gone through a systemic financial crisis since the Great
Depression. Forecasts made at the time were also subject to considerable
uncertainty about the spillovers to the rest of the world, and about how
the economy would respond to other macroeconomic policy interventions
after the federal funds rate had already hit zero. As shown in Table 3-1, in
December 2008, for example, the Blue Chip panel of economic forecasters
projected that real GDP would fall at a 1.4 percent annual rate in the first half
of 2009, less than half the 2.9 percent annualized rate of decline that actually
occurred. Moreover, the Blue Chip panel of forecasters estimated that the
unemployment rate would rise to 7.7 percent in the second quarter of 2009,
well below the actual rate of 9.3 percent. Other indicators showed similarly
large deteriorations relative to forecasts.
Initial Policy Responses
As the economy slid into recession, Congress and the Bush
Administration enacted the Economic Stimulus Act of 2008 in February.
They designed the Act to counteract a short recession by providing temporary
support to consumer spending, but it was not sufficient to reverse
the emerging distress and, by design, did not have long-lasting effects. In
fall 2008, as the initially mild recession turned into a full-blown financial
crisis, the U.S. government mounted a coordinated emergency response to
prevent a meltdown of the financial system.3 The Federal Reserve, which had
progressively cut its federal funds target rate several times over the previous
2 See Romer (2011).
3 A comprehensive timeline of the policy actions taken by the U.S. government can be found
on the Federal Reserve Bank of St. Louis website http://timeline.stlouisfed.org/
94 | Chapter 3