Arguing Over Recession Definitions – The New New Thing

US gross domestic product (GDP) fell 0.9% in the second quarter, the Bureau of Economic Analysis reports. The slide in real (inflation adjusted) output, calculated at an annual rate, follows a 1.6% decline in Q1. The back-to-back decreases immediately triggered calls that the US is in recession. But there’s also pushback from some analysts, advising that there’s room for debate. The militant wing of recessionistas quickly cried foul, and in the blink of an eye both sides are attacking the other as delusional.

In fact, both sides are right – and wrong. Some pundits would have you believe that there’s a conspiracy afoot in claiming that two back-to-back negative GDP quarters is not the first and last definition of recession. But that only appears accurate if your attention span on business-cycle analytics extends no further than the past 24 hours.

The National Bureau of Economic Research (NBER), the body that officially dates start and end dates for US recessions and expansions, has long explained that its process is more than waiting for two GDP prints to announce contraction. If you’re just discovering this now, you haven’t been paying attention. And let’s be fair: most folks don’t pay attention, probably because business-cycle analytics is a low-stakes task most of the time.

In any case, NBER makes no secret of its process: “The determination of the months of peaks and troughs is based on a range of monthly measures of aggregate real economic activity published by the federal statistical agencies,” the group advises.

This strikes some as a shocking disclosure, evidence of some deep-seated plot to mislead the public. In some of the more extreme charges, it’s all about helping the current occupant of the White House bolster his sagging opinion polls. Sigh.

The truth is far more benign and banal. It starts with the reality that the NBER’s recession-dating definitions have always been fuzzy and this has always sparked debate, but as a relatively quiet economic/econometric discussion.

If you think about this debate for 30 seconds you’ll realize that if all that’s required to call a recession is to wait for the GDP to decline for two straight quarters, there would be no point to the NBER. Joe and Mary would run the local dry cleaner could replace NBER in a heartbeat by reading the government’s GDP press releases every three months. I’m going to go out on a limb and argue otherwise: NBER’s business-cycle dates are useful for numerous reasons. But I digress.

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The bigger question is whether there’s a case for a more nuanced definition of recessions? Yes. Why? Without going down the rabbit hole, let’s simply note that for all the relevance and use of GDP, it’s a flawed metric that only partially captures the full ebb and flow of the economy. This is old news, of course. There’s long been a cottage industry of critics arguing that GDP is a poor measure of economic activity. But the demand for one all-encompassing number remains in high demand, for good or ill.

The point here is that NBER’s efforts in business-cycle dating are an attempt at going beyond GDP’s simplicity by develop a more robust methodology for calling recessions and expansions. And, yes, the group does a great job. No credible economist claims that NBER’s recession and expansion dates are wrong. Simply put, NBER is the gold standard.

The problem is that NBER’s “rules” are fuzzy and its pronouncements arrive with a significant lag. That, arguably, is the price for issuing business-cycle dates that are never revised and widely if not universally accepted as fact.

But that leaves a research hole: timely, reliable estimates of recession and expansion start and end dates? Welcome to the Wild West of business cycle analytics, where there are more methodologies than grains of sand on Waikiki. The modeling variations range from the simple to the wickedly complex and everything between.

That leads to what’s become a popular rough estimate: two quarterly GDP declines. Yes, it’s a decent if blunt tool and you could do a lot worse.

So, why not just be done with it and embrace the two-quarter rule as evidence that a recession has started? Several reasons. First, the latest GDP report will be revised several times and so the clarity that it seems to offer at the moment may become less so in the months ahead. Yup, real-time analytics are a bitch — vs. the calm, clear realm of using vintage data to state what’s happened in history.

More importantly, there are a number of other economic indicators and business-cycle benchmarks that don’t yet show a clear signal that a recession has started, including the Philly Fed’s ADS Index and the New York Fed’s Weekly Economic Index.

We can’t dismiss the possibility that a recession has arrived, but there’s still a case for debate. That debate will give way to something approximating full clarity in the weeks ahead. But for some folks, simply saying so is evidence of an evil scheme to hoodwink the masses. Fortunately, there’s an alternative (and accurate) interpretation: the data leave room for doubt.

How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report