Dating a Recession and Predicting its Demise
Few were surprised when the NBER’s Business Cycle Dating Committee announced on December 1, 2008, that the U.S. economy was in recession. However, what may have surprised some observers is that the committee dated the last business cycle peak, and hence the beginning of the recession, to December 2007. After all, the first of the two consecutive negative quarters of real GDP growth (the common rule-of-thumb definition of a recession) did not come until the third quarter of 2008 (when it fell to -0.5 percent). The previous two quarters had posted growth of 0.9 percent and 2.8 percent, respectively.
The simple answer is that the committee’s definition is both broader and less precise: “A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”
The performance of the two main employment series, nonfarm payroll employment and the BLS’s household survey, certainly look consistent with a recession dating to late 2007. The related unemployment rate series sends a similar signal. If anything, it suggests an even earlier date for the start of the recession. As of now, unemployment has already risen above the peak it hit in the last recession and is fast approaching the one it hit in the 1991 recession.
The signal is less pronounced in the two main measures of output, GDP (gross domestic product) and GDI (gross domestic income). Theoretically, the two should be equivalent, as sales of products generate income for firms and workers equal to the amount of sales, but in practice they differ by a “statistical discrepancy,” which in this case is enough to provide a muddied signal for the start of the recession. GDI was just enough weaker than GDP over the past year to indicate a downturn. GDI data for the fourth quarter of 2009 are not yet available, but GDP data for that quarter (−3.8%) leaves no doubt that the U.S. economy is in a recession now.
The Federal Reserve produces some narrower output-related measures (industrial production and capacity utilization series for manufacturing, mining, and utilities), and looking only at them would shift the dating of the recession’s onset only one month forward to January 2009. Even though both are likely to fall further, they have already dropped below their respective troughs in the last two recessions and seem likely to reach the depths of the most severe postwar recessions.
Going forward, there are at least three questions on everyone’s mind: How long? How deep? and What will be the lasting effects? While no one can answer any of these questions with any certainty, some broad outlines are possible. With most series still headed south, this will certainly be among the deepest—if not the deepest—postwar downturn. When the recovery comes, evidence from past financial crises suggest that the recession is unlikely to be V–shaped (a quick snap back). The best we can hope for seems to be a U-shaped one (more time spent in the trough). As unpromising as that may sound, that outcome would be better than an L-shaped one (a long protracted recovery).
As for lasting effects, there are likely to be many. Assuming liquidity is mopped up in a timely fashion—and much of the added liquidity is set up with incentives for that to happen as financial markets recover—then inflation should remain tamed. Also, there will be permanent changes in financial and housing markets, but what those will be depends crucially on regulatory reforms and changes in participants’ behavior that are beyond a simple summary here.
It is crucial to get these reforms right because they will determine, in part, investment going forward. Investment is keenly watched because of its influence on labor productivity—the main source of improving living standards over time. Directly, investment is needed to increase the capital-labor ratio (capital deepening), which boosts labor productivity. Indirectly, investment is often required to realize the gains that appear as multifactor productivity growth, the main source of gains in labor productivity in the long run. Productivity held up surprisingly well in the last recession even though investment as a share of GDP fell, though the gains from capital deepening did fall. If we are fortunate, the same will happen this time around.