Evan Soltas
Jul 6, 2012

How Much Did the Recession Cost?

We talk a lot about the economic loss inflicted by the 2008 recession. Unemployment, unused productive capacity, reduced potential for future production, falling household wealth, human capital depreciation via skills atrophy: all of these are ways in which economists have talked about the harm which has been wrought.

So it may help to estimate the macroeconomic opportunity cost of the recession. I've done so in this post. Although there are many other ways in which the recession has been costly -- in humanitarian terms, especially -- I look at here at two variables: (1) the real output gap since December 2007, when the NBER says the recession began and (2) the deviation of real potential output from its 2.4 percent annual growth trend.

What I find is that, depending on one's assumption of the discount rate, the macroeconomic opportunity cost of the recession is between $7.3 trillion and $12.4 trillion, using constant 2005 dollars.

In real per capita terms, that amounts to $23,300 and $39,700 respectively. As a percentage of real Q1 2012 GDP, it's 91.8% and 53.9% respectively -- implying that, roughly speaking, the macroeconomic opportunity cost of the recession ran us somewhere between six months to a full year of all economic output.

My estimates are comparable to, but generally higher than, similar estimates from Gavyn Davies of the Financial Times and Kevin Lansing of the Federal Reserve Bank of San Francisco.

A few brief comments. First, I assumed that that the economy returns to its (reduced) potential path next quarter, although it will of course not. I did not want to introduce my own forecast assumptions as to the output gap in the coming quarters. Second, I did not consider other valid macroeconomic sources of cost, such as the drop in household wealth. These two facts imply that the high-discount-rate cost estimate of $7.3 trillion should be treated as the lower-bound estimate. Third, using unemployment to estimate macroeconomic losses led me to almost identical estimates. Fourth, a high discount rate -- reflective of a belief that a real dollar in the future is worth substantially less than a real dollar today -- produces the lower total cost estimate.

Below is a graph of the incremental quarterly cost in billions of constant 2005 dollars -- therefore, my headline estimates are the sum of these values, with the future potential output carried out to infinity using the integral of exponential decay functions of the reduced potential according to the discount rate.You'll notice that the red and yellow curves measuring cost of lost potential both rise in the beginning. This is reflective of the fact that the Congressional Budget Office thinks real potential output will continue to fall below its base growth rate of 2.4 percent for several more years.