Thursday, November 03, 2011

NBER's Definition of Recession

The US economy is, at best, in the midst of one of the most sluggish expansions in memory. At worst, it's teetering on the edge of a slow slide back into recession- if it ever emerged from the recession declared to have begun in December, 2007.

Thus, it's instructive to revisit the National Bureau of Economic Research's webpages  on recession for clarification on how this official umpire of US economic phases defines recession.

"A recession is a period between a peak and a trough, and an expansion is a period between a trough and a peak. During a recession, a significant decline in economic activity spreads across the economy and can last from a few months to more than a year.

The Committee applies its judgment based on the above definitions of recessions and expansions and has no fixed rule to determine whether a contraction is only a short interruption of an expansion, or an expansion is only a short interruption of a contraction.

The Committee does not have a fixed definition of economic activity. It examines and compares the behavior of various measures of broad activity: real GDP measured on the product and income sides, economy-wide employment, and real income. The Committee also may consider indicators that do not cover the entire economy, such as real sales and the Federal Reserve's index of industrial production (IP). The Committee's use of these indicators in conjunction with the broad measures recognizes the issue of double-counting of sectors included in both those indicators and the broad measures. Still, a well-defined peak or trough in real sales or IP might help to determine the overall peak or trough dates, particularly if the economy-wide indicators are in conflict or do not have well-defined peaks or troughs."

On its FAQ page, the NBER further explains,

"Q: The financial press often states the definition of a recession as two consecutive quarters of decline in real GDP. How does that relate to the NBER's recession dating procedure?

A: Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. In 2001, for example, the recession did not include two consecutive quarters of decline in real GDP. In the recession beginning in December 2007 and ending in June 2009, real GDP declined in the first, third, and fourth quarters of 2008 and in the first quarter of 2009. The committee places real Gross Domestic Income on an equal footing with real GDP; real GDI declined for six consecutive quarters in the recent recession.

Q: Why doesn't the committee accept the two-quarter definition?
A: The committee's procedure for identifying turning points differs from the two-quarter rule in a number of ways. First, we do not identify economic activity solely with real GDP and real GDI, but use a range of other indicators as well. Second, we place considerable emphasis on monthly indicators in arriving at a monthly chronology. Third, we consider the depth of the decline in economic activity. Recall that our definition includes the phrase, "a significant decline in activity." Fourth, in examining the behavior of domestic production, we consider not only the conventional product-side GDP estimates, but also the conceptually equivalent income-side GDI estimates. The differences between these two sets of estimates were particularly evident in the recessions of 2001 and 2007-2009.

Q: How does the committee weight employment in determining the dates of peaks and troughs?
A. In the 2007-2009 recession, the central indicators–real GDP and real GDI–gave mixed signals about the peak date and a clear signal about the trough date. The peak date at the end of 2007 coincided with the peak in employment. We designated June 2009 as the trough, six months before the trough in employment, which is consistent with earlier trough dates in the NBER business-cycle chronology. In the 2001 recession, we found a clear signal in employment and a mixed one in the various measures of output. Consequently, we picked the peak month based on the clear signal in employment, as well as our consideration of output and other measures. In that cycle, as well, the dating of the trough relied primarily on output measures.

Q: Isn't a recession a period of diminished economic activity?
A: It's more accurate to say that a recession–the way we use the word–is a period of diminishing activity rather than diminished activity. We identify a month when the economy reached a peak of activity and a later month when the economy reached a trough. The time in between is a recession, a period when economic activity is contracting. The following period is an expansion. As of September 2010, when we decided that a trough had occurred in June 2009, the economy was still weak, with lingering high unemployment, but had expanded considerably from its trough 15 months earlier.

Q: How do the movements of unemployment claims inform the Bureau's thinking?
A: A bulge in jobless claims usually forecasts declining employment and rising unemployment, but we do not use the initial claims numbers in determining our chronology, partly because of noise in that data series.

Q: How do the cyclical fluctuations in the unemployment rate relate to the NBER business-cycle chronology?
A: The unemployment rate is a trendless indicator that moves in the opposite direction from most other cyclical indicators. Its level in February 1949 was the same 4.7 percent as in November 2007. The NBERhe unemployment rate is a trendless indicator that moves in the opposite direction from most other cyclical indicators. Its level in February 1949 was the same 4.7 percent as in November 2007. The NBER business-cycle chronology considers economic activity, which grows along an upward trend. As a result, the unemployment rate often rises before the peak of economic activity, when activity is still rising but below its normal trend rate of increase. Thus, the unemployment rate is often a leading indicator of the business-cycle peak. For example, the unemployment rate reached its lowest level prior to the December 2007 peak of activity in May 2007 at 4.4 percent and climbed to 5.0 percent by December 2007. On the other hand, the unemployment rate often continues to rise after activity has reached its trough. In this respect, the unemployment rate is a lagging indicator. For example, in the recovery beginning in March 1991, the unemployment rate continued to rise for 15 months after the trough. The lag was 19 months in 2001 to 2003. In the current recovery, the lag was only 4 months, from the trough in activity in June 2009 to the highest level of the unemployment rate in October 2009."

Clear enough?

What is clear is that there is no single definition by the NBER on what constitutes a US recession.

Thus the headline of a Wall Street Journal article in Monday's edition, Slow Recovery Feels Like Recession.

The NBER FAQ page includes the detail that the entity was established in the 1920s. That's relevant because evidently much of its approach dates from an era way before today's globalized supply chains and tightly-interrelated economies. Even when I studied Samuelson's Economics as an undergraduate at Saint Louis University in the late 1970s, the export component of demand (C+I+G+E) was a sort of afterthought. Now, much of the growth in revenues and profits of the S&P500 has been overseas.

What I don't think the NBER ever imagined and, even now, doesn't quite know how to consider, is a scenario, common to the US economy for over two decades now, in which GDP, based on business exports and sales in units located overseas, grows far in excess of US employment. Scenarios in which there is an absolute bifurcation in corporate profits and revenue growth from the fortunes of the US work force.

Thus, since late 2007, we've seen a disparity between business and individual economic fortunes. What the NBER won't call a recession, because, by some technical measures over which it has discretion to choose, the GDP side of the economy is growing, albeit fitfully, while the unemployment picture clearly portrays an economy still in neutral.

I've argued in prior posts that we are in an entirely new economic era with respect to phases like expansion and recession. Global trade has allowed for the growth in overall business activity for companies based in the US, but that growth, thanks to US immigration and tax policies, and comparative costs and productivity levels, is being serviced by overseas employees and operations. Thus, a lowest percentile of every nation's work forces is becoming unproductive on global terms and, thus, unemployable.

Further, in the US, the Fed's wrongheaded low-interest rate, easy money policy under Greenspan and Bernanke led to substantial overinvestment in housing, which, effectively, poured wealth into unaffordable, unnecessary homes. Fannie and Freddie, mandated by an inept Congress, further fueled this mistake with low-cost mortgages to the unqualified.

Is it really a surprise that the US is mired in an unemployment recession and a fitful, sluggish business expansion, after having destroyed so much private wealth in egregious housing investment?

It shouldn't be. In a newly-multilateral global economy where other nations, such as China, didn't make those mistakes, US economic policy mistakes now carry more immediate and significant penalties. I suspect we are now living through our first bout of such a scenario, and it won't be over anytime soon.

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