Recession: What Does It Mean?
Recession: What Does It Mean?
There’s a pretty good chance the Bureau of Economic Analysis, which produces the numbers on gross domestic product and other macroeconomic data, will declare on Thursday, preliminarily, that real G.D.P. shrank in the second quarter of 2022. Since it has already announced that real G.D.P. shrank in the first quarter, there will be a lot of breathless commentary to the effect that we’re officially in a recession.
But we won’t be. That’s not how recessions are defined; more important, it’s not how they should be defined. It’s possible that the people who actually decide whether we’re in a recession — more about them in a minute — will eventually declare that a recession began in the United States in the first half of this year, although that’s unlikely given other economic data. But they won’t base their decision solely on whether we’ve had two successive quarters of falling real G.D.P.
To understand why, it helps to know a bit about the history of what is known as business cycle dating.
A modern economy is a constantly changing thing, in which individual industries rise and fall all the time. (Remember video rental stores?) At some point in the 19th century, however, it became obvious that there were periods when almost all industries were declining at the same time — recessions — and other periods during which most industries were expanding.
To understand these fluctuations, economists wanted to compare different recessions and search for common features. But to do that, they needed a chronology of recessions, one based on a variety of measures, since G.D.P. didn’t even exist yet as a concept, let alone a number regularly estimated by the government.
A seminal 1913 book by the American economist Wesley Clair Mitchell is widely credited with beginning the systematic empirical study of business cycles. In 1920, Mitchell helped found the National Bureau of Economic Research, an independent organization that soon found itself devoting much of its research to economic fluctuations, and began offering a chronology of business cycles in 1929.
Since 1978 the N.B.E.R. has had a standing group of experts called the Business Cycle Dating Committee, which decides — with a lag — when a recession began and ended based on multiple criteria, including employment, industrial production and so on. And the US government accepts those rulings. So the official definition of a recession is that it is a period that the committee has declared a recession; it’s an expert judgment call, not a formula.
So where did the two-quarter thing come from? Part of the answer is that the N.B.E.R. doesn’t make recession calls in real time. For example, while the Great Recession is now considered to have begun in December 2007, the dating committee didn’t make that call until December 2008. Also, other nations don’t have any equivalent of the N.B.E.R. So there has always been an incentive to look for simple formulas, not dependent on judgment, that can quickly determine a recession.
Two quarters of economic contraction — a downturn sustained enough that it probably isn’t a statistical blip — seems, on the surface, like a reasonable criterion. But it’s not hard to see how it could be deeply misleading, even if the data are correct. Imagine, for example, an economy that suffered a severe slump for one quarter, then briefly stabilized and grew a bit, then resumed its plunge for another quarter. Would you really want to deny that this economy experienced a recession?
There are better indicators. The Sahm Rule, developed by Claudia Sahm, a former Fed economist currently at the Jain Family Institute, tries to identify the start of recessions by looking for significant increases in the unemployment rate. It works really well.
In fact, if we didn’t have the N.B.E.R. to make the determination, there would be a good case for viewing the Sahm Rule not as a predictor but as a definition: A recession has begun when the Sahm Rule says it has. And right now the rule emphatically does not say that we’re in a recession.
That’s partly because the G.D.P. numbers seem out of sync with many other economic indicators — part of a general picture in which economic data seem to be telling inconsistent stories. (Perhaps because, to use a technical term, we’re still somewhat discombobulated by the pandemic.) Employment growth, for example, has been solid. Is that consistent with a recession? Even gross domestic income — a number that in principle should be literally equal to G.D.P. but is estimated using different data — isn’t telling the same story, because it didn’t decline in the first quarter.
So it would be foolish to declare that we’re in a recession even if Thursday’s number is negative and the first-quarter number isn’t revised upward.
And what difference would a recession call make, anyway? What should matter is the state of the economy — which is complicated — not the particular word we use to describe it.
Unfortunately, the American political scene being what it is, we’re probably about to see a firestorm of demands both that the N.B.E.R. committee immediately declare a recession and that the Biden administration admit that one is in progress; I’m already hearing rumblings that the administration will be applying a double standard if it refuses to accept the “official” rule that two quarters of negative growth define a recession.
Well, there is no such rule. It’s quite possible that we will in fact experience a recession soon; it’s even possible, although less likely, that one has already started. But there’s no reason to use the R-word this week.
The New York Times