This Feels Like a Slump, But Is It a Recession?Published: August 15, 2001 in Knowledge@Wharton
When Fed chairman Alan Greenspan presented his semi-annual testimony before Congress last month, he said that "The period of subpar economic performance is not yet over, and we are not free of the risk that economic weakness will be greater than currently anticipated and require further policy response." That response is likely to be forthcoming when Fed policy makers meet next week on August 21. Expectations are high that they will decide to cut interest rates by another quarter-point, as they have already done six times this year, lowering the federal funds rate from 6.5% to 3.75%.
The struggling U.S. economy and Greenspan’s concern about a recession are not news. Numerous manufacturers have learned the hard way that economic conditions started to sour late last year. The nation’s unemployment rate stands at a relatively low 4.5%, but the pace of job losses seems to be increasing. In more general terms, troubles have worsened in recent months, suggesting that the U.S. economy is in recession.
Recessions usually are defined by two consecutive quarters of falling GDP, and while such an occurrence would certainly create an impression that the economy is in a downturn, the official arbiters of U.S. business cycle dating at the National Bureau of Economic Research (NBER) use more pragmatic reasoning to determine if and when a recession has occurred. The NBER designates data on payroll employment, industrial production, real income and wholesale-retail sales as the best four measures for marking turning points in the business cycle because they are almost as broad as GDP, but are available on a monthly basis while GDP figures are available on a quarterly basis.
Unfortunately, NBER procedures prevent the bureau from determining the start of a recession until it is more than six months old. Because those who worry about the impact of an economic downturn would not want to wait so long, Michael Boldin, research director of Wharton Research Data Services, spoke on behalf of Knowledge@Wharton to seven economists, including a member of the NBER dating committee. The issues ranged from whether the current slowdown is a recession, how to tell if it is one, and what this may indicate about the nature of the "new" economy.
Jeremy J. Siegel, a professor of finance at Wharton and author of Stocks for the Long Run, says that "qualitative judgement comes into play whenever one tries to differentiate a slowdown from a recession. My feeling is that we will not have an outright recession or even two consecutive quarters of declining GDP, but the way the economy has slowed is quite substantial. Given the prior euphoria over the new economy, the current deceleration, where growth went from 8% to 2% in the course of a year, feels just like past recessions where growth went from 4% to -2%."
Michael J. Boskin, chairman of the President’s Council of Economic Advisers from 1989-1993 (under George H. Bush) and now a fellow at the Hoover Institution and a professor of economics at Stanford University, offers a starker view. "The economy has stalled," he says. "Employment is shrinking, the unemployment rate is rising, incomes are flat, and industrial production has been shrinking for more than eight months.
"It will be a close call whether we narrowly skirt the technical definition of a recession," Boskin adds. "Other large industrial economies are also struggling. Japan is back in recession, continuing a lost decade. European economies are slowing, apparently two or three quarters behind the U.S. Our Asian trading partners are experiencing a sharp slowdown. Much of Latin America is in trouble."
Nobel laureate Lawrence Klein, an emeritus professor of economics at the University of Pennsylvania, believes "there is no doubt that the economy is in a significant slowdown, and this was well signaled in advance." He is cautiously optimistic about the future, based upon an early warning system that he has built using monthly, weekly and even daily real-time data. "There is a probability that a recession could occur, but our major projections have not yet turned negative. Our modeling foresees a modest recovery in the second half of the year, but certainly not back to the extremely high growth rates of late 1999," Klein says.
Mark W. Watson, a professor of economics and public affairs at Princeton University, is the co-developer with James Stock of Harvard of the Stock-Watson Experimental Business Cycle Indicators. One of their indicators, the Experiment Coincident Recession Index (XRIC), provides a real-time estimate of whether the economy is in a recession. Watson says: "Based on the indicators that we follow – industrial production, manufacturing-trade sales, income, and employee hours – the probability that the NBER Business Cycle Dating Committee will say that May 2001 was part of a recession is more than .75." (This is based on data through May for all series except sales, for which they use data through April.)
Watson admits, however, that it is premature at present to declare that the U.S. economy is in a recession. "There is not enough evidence for this call to be made now," he points out. "First, there is still an almost one-quarter chance that we aren’t in a recession, and the NBER committee needs to be very confident before making a call. Second, the four coincident series tell somewhat different stories. Industrial production shows a classic recession pattern – a reasonably sharp and steady decline since last September. Manufacturing sales figures show a similar pattern, but the recession signal is not quite as strong. Employment growth has slowed markedly, and this hints at a recession. Personal income growth has slowed, but not nearly at the rate evident in previous recessions."
Jamie Galbraith, a professor of economics at the University of Texas, is considerably more downbeat. He says the U.S. economy is on the brink of a recession and things are likely to get worse. Galbraith’s pessimism stems from his belief that "the economy suffers from fundamental problems that go beyond the IT or new economy slump. The deeper issue is the imbalance between private sector incomes and savings. The net private savings rate has been negative since 1997."
Galbraith admits that it is impossible to know exactly when households will curtail their spending after borrowing to excess, but a pullback is inevitable. "The time for reprieves is coming to an end," he says. "We are close to the start of a recession, if we are not already there. If we had not had the good luck to curtail imports more rapidly than the decline of aggregate demand, thus transferring some of the initial declines overseas, the problems and signs of a domestic economic downturn would have been even stronger."
Robert Gordon, a professor of economics at Northwestern University and a member of NBER committee, shares Gailbraith’s belief that consumer spending is the key, but he is more upbeat. "I doubt that we are now in or will soon be in a recession," he says. "The growth of personal income and consumption has continued with only a slowdown in positive growth and without any sign of a decline. Consumption is still two-third of real GDP, which will make it hard for GDP to decline as long as consumption continues to grow."
Nonetheless, Gordon sees slow growth ahead, while the consensus forecast looks for 3% or higher growth in 2002. He believes that expecting that kind of growth is too optmistic because the economy-wide profit squeeze will prevent a substantial recovery in capital spending, while "ongoing layoffs and a continuing increase in unemployment will dampen rather than revive consumer spending plans."
In some sense the economy’s near term future depends on the extent to which old business cycle patterns play out. According to Klein, "There are fundamental analytical reasons for the existence of business cycles, and it is foolish to believe that they have been abolished. These cycles reveal new features from time to time, but this does not change the fundamentals of the underlying economy." In other words, Klein argues that while unusual phases may surface sometimes, as a rule economic changes do not bring entirely new situations.
Siegel maintains that "events move faster in the new economy, and this can create as many problems as benefits. What must be most disappointing to new economy enthusiasts is the manner in which high-tech firms miscalculated the demand for their products. Sophisticated techniques for keeping inventories low relative to sales may have become commonplace, but even Cisco, for example, was stuck with a huge amount of excess inventory because the speed of obsolescence is so high for computer equipment. Thus, we have learned that the new economy is not immune to old economy issues that create business cycles."
At a time when conversations about the U.S. economy’s future seem to oscillate between gung-ho cheerleading and doomsday declarations, Boskin argues for a rational perspective. "The unemployment rate is up and likely to increase as layoffs continue in coming months. But at 4.5%, it is at a level many thought wildly optimistic a decade ago," he says. "While incomes have stagnated, and the stock market has been bearish, these changes have come after tremendous gains in income and wealth."
Boskin points out that the 1980s and 1990s saw the best macroeconomic performance in U.S. economic history, with two of the three longest expansions in history interrupted by a brief mild recession. "The boom of the late 1990s was not sustainable at that pace, either in the economy or the stock market," he says. "But a strong economy will emerge from this adjustment."