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Wednesday, June 25, 2003

What is a Recession?

Brad continues to be frustrated by the indecisiveness of the NBER Business Cycle Dating Committee. He thinks their problem is more deciding what a recession is , than pronouncing on this one. He may be right, and I agree with his diagnosis that what we have is "slow growth in demand and output accompanied by rapid underlying productivity growth and so declining employment". What I am not so sure about is where all this will lead us, and so I sympathise with the members of the NBER panel who obviously would like to avoid the embarassment of having to declare one recession officially over, only in order to announce that another one has commenced. But maybe it won't be that way, so maybe it's better to wait and see a bit more first. After all, one thing is a quiet and civilised debate among economists and another are the media and political pressures which will follow any 'official' announcement, and even more the ridicule which would then fall upon the economics profession should that call turn out to be premature, or only the harbinger of another recession. All-in-all, not an easy decision. For those who are still persplexed, here is some of the explanation:

Q: Suppose that the economy turns down this year, contrary to current forecasts. How will the NBER decide about turning points?

A:The first step would be to determine if economic activity in the period from March 2001 through early 2003 ever surpassed its peak in March 2001. If economic activity had never surpassed its previous peak, the new period of weakness would be a continuation of the recession that began in March 2001. If economic activity had surpassed its previous peak, we would need to determine whether the new period of weakness amounted to a recession. In this determination, we would refer to our standard criteria of depth, duration, and dispersion. The definition of a recession is stated in the third paragraph of this memo.

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. According to current data for 2001, the present recession falls into the general pattern, with three consecutive quarters of decline. Our procedure differs from the two-quarter rule in a number of ways. First, we consider the depth as well as the duration of the decline in economic activity. Recall that our definition includes the phrase, "a significant decline in activity." Second, we use a broader array of indicators than just real GDP. One reason for this is that the GDP data are subject to considerable revision. Third, we use monthly indicators to arrive at a monthly chronology.

Q:Could you give an example illustrating this point?

A:On July 31, 2002, the Bureau of Economic Analysis released revised figures for gross domestic product that showed three quarters of negative growth in 2001-quarters 1, 2 and 3-where previously the data had shown only quarter 3 as negative. This revision shows why the committee does not rely on a simple rule of thumb such as two consecutive quarters of negative growth, nor relies on GDP data alone, in making its determinations, but rather looks at a broader array of statistics. In November 2001, the committee determined the date of the peak in activity in March 2001 using its normal indicators. The two-quarter-decline rule of thumb would not have allowed the declaration of the recession until August 2002, let alone a declaration that it had begun early in 2001, as in the statement that the committee made in November 2001. It wasn't until eight months later that revisions in the GDP data showed declining real GDP for the first, second, and third quarters of 2001.

Q. The NBER refers to the recession as having begun in March 2001. Some observers, however, cite April as the start of the recession, reasoning that if the peak ended in March, then the recession began in April.

A: The exact peak occurred sometime in March. For the rest of the days in March, the economy was in recession. So the expansion ended and the recession began in March.

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 the economy is contracting. The following period is an expansion. Economic activity is below normal or diminished for some part of the recession and for some part of the following expansion as well. Some call the period of diminished activity a slump.

Q: How does the NBER balance the differing behavior of employment and output?

A: Following the precedents established in many decades of maintaining its business cycle chronology, the NBER considers employment, production, sales, and real income. When special factors-such as unusual productivity growth and favorable shifts in the terms of trade-make income and production-based measures move differently from those based on employment, we balance the two types of evidence.
Source: NBER

Meantime, just to make the point, the latest batch of durable goods data underline the continuing weakness of the US economy, and may well give food for thought for the FOC's rate decision due later today:

Orders for costly U.S. manufactured goods fell in May for the second month in a row, the government said on Wednesday, a sign of economic weakness that comes at a time when Federal Reserve (news - web sites) officials are meeting to discuss interest rates. U.S. durable goods orders sank 0.3 percent last month -- in contrast to the expectations of private economists that they would rise 0.8 percent. The data from the Commerce Department showed April orders plunged 2.4 percent, revised down from an earlier reported 2.3 percent drop.

The report showed broad-based weakness in demand for big-ticket items, with categories such as cars, computers and machinery showing declines. Excluding the volatile transportation sector, orders edged up 0.2 percent, a much weaker showing than the 1 percent gain projected by economists in a Reuters survey. Fed policy-makers were set on Wednesday to continue a two-day meeting on interest rates. Around 2:15 p.m. EDT, the Fed will announce its decision on rates. Analysts widely predict a cut but are split on whether it will be a quarter of a percentage point or a half point.
Source: Yahoo News

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