Recession Watch

 

While more and more economists are coming to the conclusion that our current economic slowdown may not officially qualify as one, some billionaire investors are still convinced that we are already in one. And a former Fed chairman recently bridged the gap by saying that the chances are better than 50% that we will still fall into one, if we aren't already there. A quick read of any of the major newspapers will confirm that the average citizen thinks we have been in one for months, if not years, even if that same average citizen couldn't begin to provide an accurate definition of one. Of course, by now I am sure that you are all aware that we are talking about the R word-recession.

 

With all of this talk about recession and so little understanding of what the term refers to, it seems that now may be the perfect time to clear up some of the misconceptions about what exactly is a recession and to examine some of the economic data to see if the current situation qualifies.

 

Perhaps, surprisingly, neither our government nor our statistics agencies determine when our economy has entered into a recession. Instead, that job falls to the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER), a non-profit economic research organization. According to NBER: "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."

 

A recession measures a decline in real economic activity. NBER identifies it as "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 the economy is contracting." The rest of the time the economy is expanding. It is important to note what a recession is not! It is not a period of weak or below normal growth or a period of heightened anxiety-although anxiety is usually high during a recession. Economic activity can be, and often is, below normal or weak for some time after the end of a recession, that is, during the following expansion. Such a period of weakness is more correctly labeled a "slump." 

 

The most recent economic peak was March 2001, and the most recent trough was identified as November 2001. Thus, the last recession ended in November 2001, inaugurating the current expansion that is now well into its sixth year. It is significant to point out that NBER's definition is not, as commonly reported, a two-quarter decline in real GDP. In the 2001 recession, for example, the economy never experienced two consecutive quarters of negative growth.

 

Also, while we frequently talk about recessions in housing or financial markets, sectoral declines, even severe ones, don't qualify as recessions unless they spill over to create a significant downturn in the broader economy. Taken together, the problems that we've experienced so far could lead to a recession, but their presence is not an automatic indication that we are already in one.

 

NBER tracks many monthly and quarterly indicators but pays special attention to four monthly measures in addition to real GDP. These indicators are nonfarm employment, industrial production, manufacturing, and trades sales-referred to as total business sales-and real personal income minus transfer payments.

 

Nonfarm payroll employment is perhaps the single most important indicator after GDP. On this front, there is some discouraging news. The economy lost 247,000 jobs in the first quarter of 2008, in stark contrast to the fourth quarter's 241,000 net gains.  As we write this, the rate of decline has slowed, and in May the economy lost 49,000 jobs after losing an average of 82,333 per month in the first quarter. Not surprisingly, the very severe housing contraction has contributed to the decline in jobs. Employment in the construction industry fell by 475,000 since its peak in September 2006, mainly due to losses in residential construction.

 

Another important indicator is the index of industrial production (IP), which is compiled monthly by the Federal Reserve and is broadly representative of the overall economy. It also covers many of the goods that are sensitive to changes in the econ-omy, such as consumer durables and business investment, which makes it an ideal indicator from NBER's perspective. Industrial production has been showing some weakness lately, declining in February and April but rising in January and March-certainly on the weak side but probably not indicative of a recession.

 

Another measure used to monitor the health of the economy is total business sales, which are the sum of manufacturing shipments, retail sales, and wholesale trade. The Census Bureau releases each component of business sales separately and then sums them up into a final report of total sales. The Bureau of Economic Analysis provides a measure of total business sales that are adjusted for inflation.

 

The picture here looks much like the industrial production data. On a year-over-year basis, the growth in total business sales is close to zero-certainly weak but not yet negative and still far from the levels seen during the last two downturns.

 

The final indicator that NBER formally tracks is real personal income minus government transfer payments. The data are released at the very end of each month and are subject to considerable revision. To smooth out some of the volatility, we have presented the data as a three-month moving average and then calculated the percent change on a year-over-year basis. By this measure, personal income is continuing to increase, albeit at slower rates than previously.  It is important to note that during the 2001 recession, this measure never turned negative, so it is harder to interpret the current weakness. It is generally consistent with levels seen during a recession, but it is not a clear indicator that we are in one.

 

Where does that leave us in our assessment of current economic conditions? Real GDP is weak but positive, and the other indicators we discussed confirm the weakness but remain slightly above the levels commonly associated with a recession. It is easy in this environment to understand the heightened anxiety of the general public, especially when the press accentuates the negative and virtually ignores any data not conforming to its storyline. 

 

And while it is certainly possible to get a shock, such as another energy price spike, that would send the economy over the edge, to date, the American economy has proven inc-redibly resilient. With the economic stimulus checks in the mail, and the Fed continuing to open the monetary spigot, we may yet weather the storm. In the final analysis, whether we meet the official definition of a recession or not, individuals and businesses alike will feel the very real pain of this weak economy.