recession

Why No Recession (Yet)

Scott BuchananLeave a comment

Where is that recession that pundits have been predicting for over a year now? The suspense is killing me. Despite savage hikes in interest rates that have led to a collapse in regional banks and in home buying, the economy just keeps chugging along, and inflation continues to run way above the targeted 2% level. What’s going on?

An article I just read on the Seeking Alpha applied finance website points to three interrelated factors. I will cite and credit the author (whose moniker is “Long-Short Manager”; he runs a couple of investment funds) for the content here, while noting that I agree with his points based on other reading. These points all relate to ongoing strong financial position of the (average) American consumer, who mainly drives the spending in our economy.

( 1 )  Reduced Debt Service

The article notes:

The graph above shows household debt payments as a percent of disposable personal income going back to 2000. Since peaking at 13% right before the financial crisis, it steadily improved to 2020, with a subsequent large drop due primarily to lowered mortgage rates (usually the largest debt obligation of a household). It is the lowest it has been this century.

(Although mortgage rates have jumped in the past year, most existing mortgages were taken out pre-2023, when interest rates had been pushed to near zero by the Fed.)

( 2 )  Robust Wage Growth

The next graph from the Atlanta Fed’s wage tracker (note that the methodology used by this tracker is fundamentally different from the Fed’s employment cost index …) shows that job hoppers on average are making about 3% more than core inflation (call that 5%) whereas the average stayer is making a half percent over core inflation. This is allowing people to catch up for the year that they got behind on inflation.

Likewise, the author notes that although job quits have come down in the past year, they remain well above re-COVID levels.

( 3 ) We Are Still Spending Down Gigantic Pandemic Stimulus Windfall

As we have noted earlier, the government/Fed combination dumped some $4 trillion into our collective pockets in 2020-2021. This includes enhanced unemployment benefits as well as direct stimulus payments, at a time when much of our normal spending (e.g., on travel, sports, commuting, etc.) was curtailed. We are still spending down these excess savings at a good clip, which seems to be a fundamental driver of the currently robust economy:

The last figure on the consumer shows how excess savings (defined as the extra savings consumers accumulated during the pandemic due to fiscal transfers and reduced spending due to lockdowns) has evolved – it should now be around 700 billion and ought to be fully depleted by the end of the year – leaving the consumer still with the lowest debt service ratios of the century and wages caught up with inflation. If you are wondering why we haven’t had a recession despite economists saying we will have it within 6 months for about 12 months now, these charts should tell you why. The tailwind from consumers has exceeded any headwinds from reduced investment due to higher rates. 

And there you have it.

Leading Indicators Show Incoming Recession; Lagging Indicators Not So Much

Scott BuchananLeave a comment

Here I will draw on a recent article Leads And Lags: Timing A Recession by Seeking Alpha author Eric Basmajian. His overall points are (1) that some indicators are associated with leading segments of the economy (which have historically turned down well before the rest), while others are more lagging, and (2) the leading indicators are strongly flashing recession. Direct quotes from his article are in italics.

Leading Economy, Cyclical Economy & Total Economy

When economic data is released, the information should be contextualized based on where the data point falls in the economic cycle sequence.

We can separate the economy into three buckets: the Leading Economy, the Cyclical Economy, and the Total Economy.

The Leading Economy is defined by the Conference Board Leading Index, which is a basket of ten leading economic variables such as building permits, new orders, and stock prices.

The Leading Index has turned negative before every recession, without exception.

Conference Board, Census Bureau, BLS, BEA, Federal Reserve

The Cyclical Economy represents the construction and manufacturing sectors. The Cyclical Economy is the driving force behind recessions, always turning negative before the Total Economy, and never giving a false signal; when the Cyclical Economy turns negative, the Total Economy turns negative several months later.

Conference Board, Census Bureau, BLS, BEA, Federal Reserve

The Total Economy is defined by the “Big-4” Coincident Indicators of economic activity. Nonfarm payrolls, real personal income less transfer payments, real personal consumption, and industrial production are four major economic indicators that the NBER uses as the core of their recession dating procedure.

Conference Board, Census Bureau, BLS, BEA, Federal Reserve

A sustained contraction in the “Big-4” Coincident Indicators is the definition of a recession.

The Total Economy starts showing contracting growth rates about four months into the recession.

Could This Time Be Different?

If we do finally get a recession, it will be probably the most long-expected recession ever. Pundits have been warning for over a year that the Fed’s well-telegraphed program of rate hikes will crater the economy, as the only way to tame inflation.

According to Basmajian, When the Leading Economy and Cyclical Economy are both lower than -1%, a recession, as dated by the NBER, occurred an average of 5 months later, with a range of a 4-month lag to a 14-month lead.

His Leading indicator went negative about 11 months ago (June, 2022). However, it looks like the economy is still humming along and employment remains robust. His Cyclic Economy is on track to go negative right about now, but that has an unusually long lag between Leading and Cyclical:

The Cyclical Economy will likely turn negative with April data and potentially below -1% by May data should the current downward slope remain.

That would push the lag between the Leading Economy and the Cyclical Economy to 11 months, the longest on record.

And the lag before we finally get a bona fide recession in the Total Economy may keep dragging out longer yet. There is even a possible Soft Landing scenario where the rate hikes manage to cool the economy down without causing a severe recession at all.

It seems to me that we collectively are still spending down our excess pandemic benefits, and no recession will come till we finish running through those monies.

The Murky Macro Picture

James Bailey2 Comments

Last June I wondered if we were seeing the peak of inflation, and by at least one major measure I called the peak exactly:

At the moment, though, I’m feeling more confused than prophetic. The big question a year ago was how long it would take the Fed to get inflation down to reasonable levels, and how much collateral damage they would do to the real economy in that effort. Today most current indicators make it look like they pulled off the miraculous “soft landing”. Inflation over the last 12 months is still high, but over the last 6 months we’re nailing the Fed’s 2% annualized target. This has hit a few sectors of the real economy hard, with housing slowing dramatically and tech doing mass layoffs, but the overall picture is great: GDP growth was around 3% the last 2 quarters, and the 3.4% unemployment is the lowest since 1969.

What’s confusing about this is that we have a hard time believing we really got this lucky. Its like your plane lost power, you diverted course for an emergency crash landing, and once you touch down and find yourself seemingly unharmed you look around and wonder if the plane is about to explode. Consumer sentiment is worse than it was in the depths of Covid; business sentiment has been falling for over a year and is almost down to March 2020 levels. Betting markets forecast a 50% chance of a recession in 2023, and the yield curve is strongly inverted (one of the best predictors of a recession, though the guy who first noticed this says it might not work this time):

Finally, M2 money supply is shrinking for the first time since at least 1960, and I believe the first time since the Great Depression. This bodes well for inflation continuing to moderate, but its also one more indicator of a potential recession.

To sum up, most of the indicators of the current state of the economy look great, while most indicators of its near-term future look awful. So which do we trust?

My guess is that we avoid recession in 2023, but honestly this is mostly the gut feeling of an optimist. There’s no one knock-down piece of data I’d point to in support; its more that things are currently going well, and usually the best prediction is that tomorrow will be like today unless you have a good reason to think otherwise. The main reason people expect a slowdown is because of the Fed’s actions to fight inflation. The Fed itself predicts that they will cause a slowdown, but not a recession. Their most recent summary of economic projections from December predicts GDP growth slowing to 0.5% in 2023 and unemployment rising to 4.6%.

I think the “so what” outlook is also murky. Stocks have already fallen a lot from their highs and a recession already seems somewhat ‘priced in’, so even if I thought one was coming I wouldn’t necessarily sell stocks. On the flip side US stocks are still quite expensive by historical standards, so I don’t want to buy more on the assumption that they’ll rise more on good economic news this year. You might want to lock in decent rates on long-term bonds if you think the Fed will cut rates in response to a recession, but the inverted yield curve shows this is already somewhat priced in. 1-year bonds yielding almost 5% seems decent in either scenario, I have some and I’ll probably buy more, but 5% returns are nothing to get excited about. I’d like to hear suggestions but to me the small direct betting market on a potential recession is the clearest “so what” for anyone who does have a confident view about this year’s macro picture.

The “Textbook Definition” of a Recession

Jeremy Horpedahl3 Comments

Three weeks I wrote a blog post about how economists define a recession. I pretty quickly brushed aside the “two consecutive quarters of declining GDP,” since this is not the definition that NBER uses. But since that post (and thanks to a similar blog post from the White House the day after mine), there has been an ongoing debate among economists on social media about how we define recessions. And some economists and others in the media have insisted that the “two quarters” rule is a useful rule of thumb that is often used in textbooks.

It is absolutely true that you can find this “two quarters” rule mentioned in some economics textbooks. Occasionally, it is even part of the definition of a recession. But to try and move this debate forward, I collected as many examples as I could find from recent introductory economics textbooks. I tried to stick with the most recent editions to see what current thinking on the topic is among textbook authors, though I will also say a little bit about a few older editions after showing the results of my search.

Undoubtedly, I have missed a few principles textbooks (there are a lot of them!) so if you have a recent edition that I didn’t include, please share it and I’ll update the post accordingly. I also tried to stick with textbooks published in the last decade, though I made an exception for Samuelson and Nordhaus (2010) since Samuelson is so important to the history of principles textbooks (and his definition has changed, which I’ll discuss below).

But here’s my data on the 17 recent principles textbooks that I’ve found so far (send me more if you have them!). Thanks to Ninos Malek for gathering many of these textbooks and to my Twitter followers for some pointers too.

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Recession or not, the biggest GDP political football is 3 months away

James BaileyLeave a comment

US GDP fell for the second straight quarter according to statistics released this week by the Bureau of Economic Analysis. This means that by one common definition we’re now in a recession, which has ignited a debate about whether “two consecutive quarters of negative GDP growth” is the best definition (as opposed to ‘when the NBER says there’s one’, like I generally teach and Jeremy argued for here, or something else).

Naturally this debate has political overtones, since the party in power would be blamed for a recession, so we’ve seen the White House CEA argue that we’re not in a recession, many on the other side argue that we are, and plentiful hypocrisy from people who should know better.

But in political terms, the fight over the binary “are we in a recession” call won’t be the big economic factor in November’s elections- that will be inflation and GDP, especially 3rd quarter GDP. One of the oldest and best predictors of US elections is the Fair Model, which uses inflation and the number of recent “strong growth quarters”. Fair’s update following the recent Q2 GDP announcement states:

the predicted vote share for the Democrats is 46.70, which compares to 48.99 in October. The smaller predicted vote share for the Democrats is due to two fewer strong growth quarters and slightly higher inflation

By Election Day we’ll have 3 more months of economic data making it clear whether inflation is getting under control and whether economic activity is picking back up or continuing to decline. Monthly data releases on inflation and unemployment will be closely watched, but the most discussed release will likely be third quarter GDP. It will summarize 3 months instead of just one, it will be of huge relevance to the debate over how severe the recession is or whether we’re even in one, and it will likely be released less than two weeks before election day. The NBER almost certainly won’t weigh in by then; they tend to take over a year to date recessions, not adjudicate debates in real time.

So when BEA does release their Q3 GDP estimate in late October, what will it say? Markets currently estimate at least a 75% chance it will be positive (they had estimated a 36% chance of positive Q2 GDP just before the latest announcement). That sounds high to me, the yield curve is still inverted and I bet investment will continue to drag, but forecasting exact GDP numbers is hard. Its a much easier bet that whatever the number turns out to be will loom large in political debates just before the elections. Perhaps we’ll get the Q3 GDP growth number that would make for the most chaotic debate: 0.0%.

Is the Bottom Quartile Already in Recession?

Scott Buchanan2 Comments

I heard on a radio interview that spending by the bottom quartile is way down in 2022, while it is holding up merrily for the upper two quartiles. My mind jumped to the thesis:

“Hmm, the bottom quartile probably (proportionately) felt the benefit of the three COVID stimulus packages more, plus they would have benefited more, proportionately, from the enhanced 2020-2021 unemployment benefits, which (I gathered from anecdotal observations) often paid them more for staying home than they used to receive for working. But…by 2022, all that extra money may be running out.”

I spent some time poking around the internet, trying to find some pre-made figures or tables to support or disprove this thesis. What I found tended to support it, but this is not rigorous data-mining. So, for what it is worth, here are some  charts.

First, about the spending in 2022. This chart indicates that discretionary service spending by the bottom 40% income cohort is indeed down sharply in  2022, and now sits a little lower than a  year ago, while the upper 20% cohort is spending actually more than a year ago.  Spending by the middle 40% trended up in 2H 2021, then back down in 1H 2022, to end about even over the past 12 months:

Discretionary service consumption by income cohort. (I don’t what the units are for the y-axis, but presumably they show the trends). Source: Earnest Research, as of June 30, 2022, as reproduced by Blackrock.

And what about 2020-2021? The next two charts indicate (a) that consumer spending was HIGHER in 2021 that it was pre-COVID for the bottom income quartile, even though (b) their employment in 2021 remained some 20% LOWER than pre-COVID. Looks to me like a lot of spending of stimmie checks was going on in 2021, but (see above) that money has run out in 2022.

Some reader here may have access to a more consistent data set, so I am happy to see this thesis tested further.

Consumer Spending by Income Quartile (Showing higher spending by bottom quartile following stimulus checks and enhanced unemployment payments in 2020-2021)  Source: The Economic Impacts of COVID-19: Evidence from a New Public Database Built Using Private Sector Data, Stepner et al. (2022).

Employment Changes by Wage Quartile ( Showing employment for the bottom quartile in most of 2021 was some 20% lower that pre-COVID)  Source: The Economic Impacts of COVID-19: Evidence from a New Public Database Built Using Private Sector Data, Stepner et al. (2022)   

Are We in A Recession?

Jeremy Horpedahl3 Comments

The truth is, we don’t know. But let’s be clear: whether we are or not doesn’t depend on the 2nd quarter GDP report. Though two consecutive quarters of declining GDP is often cited as the definition of a recession, it’s not the definition economists use. And with good reason.

Instead, the NBER Business Cycle Dating Committee uses this definition: “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” And they explain why GDP is not their preferred measure, which includes several reasons but this one seems most germane to our current moment: “[the] definition includes the phrase, ‘a significant decline in economic activity.’ Thus real GDP could decline by relatively small amounts in two consecutive quarters without warranting the determination that a peak had occurred.”

If not GDP, what do they look at? I’ll get into more detail later, but in short, they look at monthly measures of income, consumption, employment, sales, and production (a direct measure of production, which GDP is not — it’s a proxy).

However, the American public seems convinced that we are in a recession. The most recent poll I can find on this is from mid-June, which is useful because (as we’ll see below) we have most of the relevant measures of the economy for June 2022 already. In that poll, 56% of Americans say we are in a recession. And while there is some partisan bent to the responses, even 45% of Democrats seem to think we are in a recession. For those that say we are in a recession, 2/3 cite inflation as the primary indicator that we are in a recession.

Already here we can see the difference between the general public and NBER: the rate of inflation is not one of the measures that NBER considers when defining a recession. So, what are the measures they use?

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It’s Still Hard to Find Good Help These Days

Zachary Bartsch2 Comments

Consumption is the largest component of GDP. In 2019, it composed 67.5% of all spending in the US. During the Covid-19 recession, real consumption fell about 18% and took just over a year to recover. But consumption of services, composing 69% of consumption spending, hadn’t recovered almost two years after the 2020 pre-recession peak.  For those keeping up with the math, service consumption composed 46.5% of the economic spending in 2019.

We can decompose service consumption even further. The table below illustrates the breakdown of service consumption expenditures in 2019.

I argued in my previous post that the Covid-19 pandemic was primarily a demand shock insofar as consumption was concerned, though potential output for services may have fallen somewhat. When something is 67.5% of the economy, ‘somewhat’ can be a big deal. So, below I breakdown services into its components to identify which experienced supply or demand shocks. Macroeconomists often get accused of over-reliance on aggregates and I’ll be a monkey’s uncle if I succumb to the trope (I might, in fact be a monkey’s uncle).

Before I start again with the graphs, what should we expect? Let’s consider that the recession was a pandemic recession. We should expect that services which could be provided remotely to experience an initial negative demand shock and to have recovered quickly. We should expect close-proximity services to experience a negative demand and supply shock due to the symmetrical risk of contagion. Finally, we should expect that services with elastic demand to experience the largest demand shocks (If you want additional details for what the above service categories describe, then you can find out more here, pg. 18).

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This Time was Way Different

Zachary Bartsch5 Comments

The financial crisis recession that started in late 2007 was very different from the 2020 pandemic recession. Even now, 15 years later, we don’t all agree on the causes of the 2007 recession. Maybe it was due to the housing crisis, maybe due to the policy of allowing NGDP to fall, or maybe due to financial contagion. I watched Vernon Smith give a lecture in 2012 in which he explained that it was a housing crisis. Scott Sumner believes that a housing sectoral decline would have occurred, and that the economy-wide deep recession and subsequent slow recovery was caused by poor monetary policy.

Everyone agrees, however, that the 2007 recession was fundamentally different from the 2020 recession. The latter, many believe, reflected a supply shock or a technology shock. Performing social activities, including work, in close proximity to others became much less safe. As a result, we traded off productivity for safety.

The policy responses to each of the two were also different. In 2020, monetary policy was far more targeted in its interventions and the fiscal stimulus was much bigger. I’ll save the policy response differences for another post. In this post, I want to display a few graphs that broadly reflect the speed and magnitude of the recoveries. Because the recessions had different causes, I use broad measures that are applicable to both.

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The Recession Is Over! (15 months ago)

Jeremy HorpedahlLeave a comment

Lately there has been lots of both good and bad news about the pandemic and its impact on the economy. But here’s once piece of good news you might have missed: the recession which began in February 2020 ended in April. And not April 2021… it ended in April 2020. At least, that’s according to the NBER Business Cycle Dating Committee, which made the announcement last week.

The 2020 recession of just 2 months is by far the shortest on record. NBER maintains a list of recessions with monthly dates going back to 1854 (there are annual business cycles dates before that, including important modern revisions of the original estimates, but the monthly series starts in 1854). In that timeframe, there have been 7 recessions in the 6-8 month range, but nothing this short. Still, it was mostly definitely a recession, as unemployment briefly spiked to levels not seen since the Great Depression. But only for 2 months. Keep in mind that the first part of the Great Depression last 43 months.

Unemployment Rate, 1948-present

But how can this be? Is the recession really over? There are still about 6-7 million fewer people working than before the pandemic began. Lots of businesses are still hurting. The unemployment rate is still 2 full percentage points above pre-pandemic levels. How in the world can we say the recession ended 15 months ago?

To answer that question, it helps to know what NBER and most macroeconomists mean by a “recession” — essentially, it is used interchangeably with “contraction.” It means the economy, by a broad array of measures (NBER uses about 10 measures), is shrinking — or we might say, going in the wrong direction. The only other option, at least in the NBER chronology, is an expansion — when the economy is going in the right direction.

Does an economic expansion mean that everything is fine the economy?

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