Some prominent institutional bond investors are shifting their focus away from traditional benchmark indices that weight countries’ debt issues by market capitalization, toward GDP-weighted indices.   PIMCO (Pacific Investment Management Company, LLC, the world’s largest fixed-income investment firm) and the Government Pension Fund of Norway (one of the world’s largest Sovereign Wealth Funds), have both recently made moves in this direction.  

There is a danger that some investors will lose sight of the purpose of a benchmark index.   The benchmark exists to represent the views of the median investor dollar.  For many investors, going with the benchmark is a good guideline - especially those who recognize themselves to be relatively unsophisticated and also those who think they are sophisticated but really aren’t.   This is the implication of the Efficient Markets Hypothesis (EMH), for example.  

On the one hand, EMH theorists are often too quick to discount the possibility of ways to beat the benchmark.   To take an example, it should not have been so hard to figure out during the 2003-07 credit-fed boom that countries with high foreign-exchange-denominated debt, particularly in Europe, were not paying a sufficiently high return to compensate for risk.  That mistake described Eastern European countries with low ratios of reserves to short-term debt as well as periphery euro members that lacked their own currency.  It probably resulted from easy money, reach for yield, and pervasive underestimation of risk.  Or, to take another example (admittedly, a tougher call), some of these countries’ deeply discounted bonds would have been good buys in early 2012, after heavy mark-downs.   

On the other hand, most investors would do better if they went with a more passive investment strategy - especially due to high management fees among actively managed funds, exacerbated by excessive turnover.   At a minimum, if one is pursuing an activist strategy such as investing more in low-debt countries, it is helpful to frame it explicitly as a departure from the view of the median investor in order to be clear in your mind as to the nature of the bet you are making.

I can think of four functions of a benchmark index.    First, investors who do not figure that they can systematically beat the median investor need to be able to hold passively a portfolio designed to track a benchmark index consisting median investor holdings.   (See Vanguard.)   The second function is to provide an objective standard by which investors can judge the performance of active portfolio-managers who claim to be able to beat the median investor, within a specific asset class like sovereign debt.  (See Morningstar.)   Third, the same weights that are used in the index can be used to compute an average interest rate or sovereign spread in the market, which can serve as an indicator as to where the median investor is currently, in the risk-on, risk-off spectrum. (See J.P.Morgan’s EMBI — Emerging Market Bond Index.)    

The fourth function of a benchmark index is to help active investors to devise a deliberate strategy to depart from the views of the median investor when they think that the latter is erring in a particular direction.  They may think that the median investor is under-estimating risk in general (spreads too low) or under-estimating the downside in countries with some particular characteristic.   Examples of such characteristics include insufficient currency flexibility, inadequate reserves, too much short-term debt, too much foreign-currency debt, too much bank debt, insufficient openness to FDI, insufficient cost competitiveness, excessive budget deficits, insufficient national saving, political risk, and so forth.

For each of these four functions of a benchmark, the correct way of weighting different countries is by market capitalization.  True, the keeper of the index will need to judge what countries and what bonds are in “the market,” i.e., are fully investable.   But this is true for any index.

The logic behind the movement away from traditional bond market indices is that by construction they give a lot of weight to countries with high debt, some of which may be over-indebted and at risk of default.  At first the logic seems unassailable.  But in theory, if the market is functioning well, it should already have factored in high debt levels:  such countries should pay higher interest rates to compensate for the risk, unless there is some special reason to think they can service their debts easily.

It is important to emphasize that many investors will want to depart from the benchmark in various directions, as indicated under the fourth motive for having a benchmark.  An investor’s belief that countries with high debt/GDP ratios are riskier than the median investor realizes would call for a strategy equivalent to moving from the market-cap benchmark in the direction of the GDP-weighted benchmark.  But one is more likely to think about the strategy clearly if it is explicitly phrased in terms of factoring in debt/GDP ratios, rather than phrased as following a new GDP-weighted index.  Furthermore the phrasing may help an investor realize that he or she might want to modify the strategy if, for example, the country in question can borrow readily in terms of its own currency (think of American exorbitant privilege or Japan’s high domestic holdings of own debt) or if, on the other hand, its debt has a particularly vulnerable maturity or currency structure (think of Hungary).

Investors are reacting to what has turned out to be default risk that was higher than they had expected, among some high-debt countries.  Taking greater note of high debt levels last decade would have warned investors away from countries like Greece and Hungary.   But there is always a danger of fighting the last war.   Middle-income countries have paid down much of their debts over the last decade, attaining debt/GDP ratios far below those of advanced economies.    As the chart shows, major emerging markets have relatively low debts [first bars, for each country] compared to GDP [second bar].  That is, their debt/GDP ratios [third bar] are now much lower than in advanced countries.  (Russia’s sovereign debt is now below 7 per cent of GDP.)  As a result, there is only a limited supply of their bonds left to hold.  If the global investor community switches from market-cap-weighted to GDP-weighted investing, the high demand and low supply of bonds from low debt/GDP countries may drive their interest rates to unnaturally low levels, setting off new credit-fed boom-bust cycles in their economies.  

Of course, as a country’s international debt approaches zero, the keepers of the index might drop it altogether.  But the fall in demand for that country’s remaining international bonds from the investment funds that are following the benchmark could then produce an undesirable discontinuous jump in the interest rate.

Many emerging market countries have paid down debt denominated in dollars or other foreign currencies, while continuing to borrow in their local currencies.  (See the table at bottom.)  Such relatively large countries as Thailand, Malaysia, Indonesia, South Africa and Russia, for example, have little dollar-denominated debt left - 3% of GDP or less (shown in the chart as the dark bottom of each first bar).   If an international bond benchmark is to be limited to dollar-denominated debt, then GDP weights could imply a severe imbalance between international investor demand for these countries’ bonds and the small supplies available. 

Accordingly, local currency denominated debt must be included in the most useful benchmarks.  But then a portfolio reallocation away from traditional benchmark indices such as the EMBI would imply a big shift in allocations away from simple credit risk toward currency risk.   True, the ability of emerging market economies to attract foreign investment in their local currencies represents an important strengthening of the global financial system, relative to the currency mismatch and balance sheet vulnerabilities of the 1990s.  Nevertheless, an investor switching from one “benchmark” to the other needs to be aware of the extent to which the reduction in default risk comes at the expense of heighted exposure to currency risk.

In short, it is not crazy for an investor to depart from the market-cap-weighted benchmark in the direction of putting more weight on debt/GDP countries and less weight on high debt/GDP countries.   But the GDP-weighted index should not be mistaken for a neutral benchmark.

[A version of this post originally appeared at Project Syndicate, Feb. 11, 2013.  Comments can be posted there, or at Seeking Alpha.]

Table:  Sovereign debts as a percentage of GDP

This morning the Bureau of Economic Analysis released its first estimate for 2011 GDP.   It showed national output for the first time surpassing the pre-recession peak, which occurred in the last quarter of 2007.    (See chart below)    The expansion in 2011 was led by autos, computers, and other manufactured goods.

Given that the economy hit its trough in mid-2009, the long slow climb since then has been disappointing.   The outcome turns out to have been worse than the conventional wisdom that sharp declines tend to be followed by sharp recoveries.   On the other hand, the outcome turns out to have been somewhat better than the Reinhart-Rogoff thesis that when the cause of a recession is a financial crisis, the recovery tends to take many years.  

To be sure, the housing market has yet to recover and households are still painstakingly rebuilding their battered balance sheets.   But is this the complete explanation for the disappointing state of the economy — the origins of the crisis in a housing bubble and financial collapse?   

The first point to note is that the biggest single reason why the level of GDP over the last three years has been lower than most people forecast in January 2009 has nothing to do with overly optimistic forecasts in January 2009 of the rate of growth looking forward, nor with how good or bad Obama’s policy proposals were, nor with how effective the Republicans turned out to be at blocking them.  The BEA subsequently revised the GDP statistics substantially downward, and now reports that the real growth rate of the economy in the last quarter of the Bush Administration, instead of negative 3.8% per annum as reported that January, was in fact negative 8.9% per annum! The trough of the V was far deeper than was realized at the time.

The second point to note is that construction, which usually helps lead the economy out of a recession, remained, indeed had a strong negative influence on GDP throughour 2006-2010.   Fortunately, in the latest figures, residential construction finally returned to a (small) positive source of growth in the economy over the last three quarters.

The third point to note is that the government sector has been the one component of demand to exert a substantial negative effect througout the last five quarters.   The reason is the withdrawal of fiscal stimulus at the federal level, at a time when state and local governments are also cutting back sharply on spending and employment. 

              The NBER’s Business Cycle Dating Committee, of which I am a member, announced this morning that June 2009 was the trough of the recession that began in December 2007.    It was the longest recession since the 1930s.

              It is the fate of the Committee to be teased mercilessly every time we make one of our formal declarations of a turning point in the economy.   We get it from both directions:    We waited too late to call the end of the recession, or we did it too early.     (Occasionally someone makes both criticisms simultaneously!)   Even The Daily Show got in on the fun this time.

              On the one hand, people say “Who needs the NBER to tell us what we already knew?”    It is true that GDP has been expanding for 5 quarters now, and that most economists have therefore considered the recession over for some time.   But it is not that easy to call the precise trough, for several reasons:  different indicators say different things regarding the precise date of the bottom, data get revised, and we could not have been confident until now that a hypothetical new downturn would count as a second recession instead of a continuation of the first one.    Does the 15-month lag in this announcement seem like a long time?  It took us 18 months to declare the end of the preceding recession (2001).

              On the other hand, people say “It doesn’t feel like the recession is over to me or to people I know.  How can the NBER be so out of touch?”   The main answer, here:  The proposition that the recession is over is only a statement that things are no longer getting worse; it is not a statement that we are back to good times.    The economy still feels bad for good reason:  it is bad.  In particular the unemployment rate is still very high.   But things are much better now than they were 18 months ago, when the economy was in freefall, or in mid-2009, when we were at the bottom of the worst downturn since the Great Depression.  It takes a long time to emerge fully from a hole that deep.  And, to be sure, the current pace of the expansion is disappointingly slow, especially with respect to jobs.  But GDP and employment are, at least, rising.

              The other question that we are asked the most is whether one should worry about a double dip recession.  The NBER does not forecast.  I can speak only for myself.    The possibility of a new downturn is indeed a concern, especially because Washington has been unable to deliver a sensible fiscal response. (A sensible policy in my view would consist of some more stimulus, as in February 2009, designed to maximize bang-for-the-buck, coupled with simultaneous steps to move the long-term fiscal path back toward responsibility, such as social security reform).    But even without an appropriate fiscal response, I am optimistic that we can avoid sliding back into a second outright recession.  More likely, we will have a slow continuation of the current (inadequate) recovery.

On July 31, the Department of Commerce’s BEA (Bureau of Economic Analysis) released an important set of numbers regarding GDP.  Of most immediate interest, the advance estimate of GDP growth for the second quarter, April-June, 2009, was a very moderate -1 per cent per annum.  The small magnitude of this negative number confirms an inflection point in the second quarter.   As most of us had already thought, the economy is no longer in the free-fall of October 2008 to March 2009 — when the rate of output contraction was approximately 6% per annum – but, rather, is beginning to level out.     

Furthermore, the figures reveal large depletion of inventories in the second quarter, which offers good grounds for hope that firms will begin to produce more in the second half of the year.  In other words, the economy is probably bottoming out even as we speak.

But even if it turns out that the NBER Business Cycle Dating Committee eventually puts the trough sometime in the 2nd half of 2009, it will not make that decision until all the facts are in, which will be a long time.    A major reason is that government statistics, especially for GDP, are always revised subsequently.   That brings us to the other big component of the BEA release on Friday:  comprehensive revisions to the GDP numbers going back many years.    The BEA does a comprehensive revision generally every five years.  In this case the statistics were substantially affected, especially those over the last dozen years, as the results of a number of permanent changes in methodology (such as how natural disasters are treated in the accounts).   

These revisions produced two interesting implications for the current recession, quite aside from the question whether it is now ending.  

First, the recession turns out to have been worse than the previous GDP numbers indicated.  During the course of 2008, the economy apparently contracted 1.9%, more than double the previous estimate of 0.8%.      The cumulative decline through the 2009 Q-I now appears to have been 2.8% (as compared to the previously reported 1.8%).    Add in the latest quarter, and the 3% cumulative decline cements the claim of this recession to be the worst since the 1930s.

Second, that revision includes a conversion of the +0.9% that was previously reported for the first quarter of 2008 to the new estimate for that quarter:  -0.7%.

That is important from the viewpoint of the NBER Business Cycle Dating Committee.   Why?     All through 2008 it was difficult to tell whether a recession had started at the end of 2007.   On the one hand, some measures such as employment and real income had peaked then,  but on the other hand it appeared that GDP had continued to grow in early 2008.     Even after the accelerated deterioration in the autumn of 2008, when it could no longer be doubted that the economy was in recession, the signals as to the date of its beginning still conflicted.     

The Committee ended up, on December 1, 2008, declaring that the peak had occurred in December 2007.    As always, there were critics.   Some didn’t see how we could declare that a recession had begun six months before GDP growth turned negative.   “Everybody knows that a recession is defined as two consecutive negative quarters”     (More common, as usual, was the precisely opposite critique:   “The NBER is just now saying what has long been obvious to everyone but them.”)

The new report from the BEA that the first quarter of 2008 was negative after all is thus another piece of evidence that validates the choice of end-2007 as the business cycle peak.   Similarly, it validates the decision by the Committee to have made the call in December, rather than waiting for the BEA revisions of July 31, 2009.  

The bottom line of all of this?    We are less at sea than we had feared.   The data now tell a story that is fairly well delineated, the story of a recession that, though upsettingly severe in amplitude, appears familiarly sinusoidal in shape.

(This post does not necessarily represent the views of the NBER Business Cycle Dating Committee or its members.  Nor of the BEA or its Advisory Committee members.)

———————————————————————————————————————————————————–

                                                              I 06   II 06 III 06  IV 06                          I 07  II 07 III 07     IV 07                            I 08    II 08      III 08       IV 08                 I 09

Newly reported GDP        5.4    1.4     .1    3.0               1.2    3.2    3.6    2.1                    -.7    1.5       -2.7     -5.4           -6.4       

Previously published.      4.8    2.7     .8    1.5                 .1    4.8    4.8    -.2                    +.9      2.8       -.5       -6.3         -5.5

 

[Any readers wishing to post comments are encouraged to go to Seeking Alpha.]

 

The Commerce Department this morning announced its advance estimate of last quarter’s real GDP. As expected, the estimate shows that GDP fell in the first quarter of 2009 — by a hefty 6.1 per cent at an annual rate. An implication is that the current recession has just tied the post-war record for longevity.

The previous record-holders were the recessions of 1973-75 and 1981-82, each of them five quarters in length according to the official NBER chronology.  In the current downturn, the NBER’s Business Cycle Data Committee determined that the economy peaked in the 4th quarter of 2007. Although the Committee won’t declare the trough of the recession until well after the fact, and the trough could well be a ways off, a negative 1st quarter of 2009 almost certainly means that the five-quarter benchmark has now been attained.  (The Commerce Department often revises its GDP figures substantially between the advance estimate and the final number, and we are due for major backward-looking revisions in July.  Indeed that is one reason why the NBER always waits so long to issue its findings.  In the past, the size of the average revision has been just over 1 percentage point, whether up or down.   It is highly unlikely that future revisions will change this morning’s negative number into a positive one.)

The NBER also keeps a more precise monthly chronology. The postwar record is 16 months, again shared by the 1973-75 and 1981-82 recessions. To match this monthly benchmark, the current downturn would have to have continued into April. Our best single indicator as to whether it did so will be the employment number to be released by the Bureau of Labor Statistics next Friday, May 8. It almost certainly will show that there were further job losses in April. If so, it will further confirm the dismal conclusion: one would have to go back 80 years, to the disaster of 1929-1933, to find a longer recession.

[Readers who wish to post comments are advised to go to the posting at Seeking Alpha.]

The National Bureau of Economic Research today announced that its Business Cycle Dating Committee had officially determined a peak in economic activity at December 2007, which signals the start of the recession.    I am a member of the committee.    Though I speak only for myself, not the committee, I offer my views on two questions of possible interest: 

(1)   Who needs the NBER Business Cycle Dating Committee (BCDC) anyway?

(2)   Why did we pick December 2007 as the starting month of the recession?

(1) We sometimes hear the question “Who needs the NBER Committee anyway?”   This question most often comes in one of two forms:

(1a)  Everyone in the real world has known that the economy has been in a recession for some time.   In past cycles, media reports have sometimes taken the line “Ivy Tower Eggheads Finally Figure Out What Everybody Else Has Known All Along.”    The implicit critique is that the committee takes too long after the event – typically almost a year — to make its declaration.   One short answer is that our job is to be definitive, authoritative, but not fast.  We don’t want to have to revise our dating of the peaks and troughs later, in part because it would sow confusion among those who rely on them (from econometric researchers to political speechwriters).   GDP and other official statistics are often revised after the fact, for example.  We leave it to others  –pundits, forecasters, consulting companies, financial newsletters, and so on – to try to get there first.   We deliberately get there last.

(1b)  The other form taken by the question “Who needs the NBER committee?” runs as follows: “The rule of thumb is simple:  two consecutive negative quarters of GDP growth.   Why complicate things?”    The Frequently Asked Questions segment of the BCDC announcement answers this in detail.     For now, observe simply that questions (1a) and (1b) are inconsistent with each other.    As of December 1, 2008, the US economy has not yet experienced two consecutive negative quarters.    So an argument that we should wait for two consecutive quarters (critique 1b) is the opposite of the critique that we should have acknowledged a recession before now (critique 1a).

(2) The more important question is:  Why did we pick December 2007 as the start of the recession?    As is the case surprisingly often, different economic indicators give very different answers to the date of the peak.

            Of the monthly indicators to which the BCDC gives primary attention, the most important is jobs, more specifically Payroll Employment (from the Labor Department’s Bureau of Labor Statistics).   It peaked in December 2007, and has been declining ever since.   My personal favorite indicator is Total Hours Worked (which is closely related, because it is number of people employed times the average number of hours per worker).    Hours Worked also peaked in December, as shown in the graph below.

            Of the quarterly indicators, the most important is aggregate economic activity, more specifically, Output.   The Commerce Department’s Bureau of Economic Analysis computes two measures of output:   Gross Domestic Product (GDP) and Gross National Income (GNI).  The two should be the same in theory, but differ in practice due to measurement errors.   GDP receives far more public attention – in part because its advance estimate comes out first — but in fact has no claim to be a more accurate measure of output than does National Income.    The statistics currently available show that GNI peaked in Quarter 3 of 2007, whereas GDP peaked in Quarter 2 of 2008.    A simple-minded average of the two peak dates would seem to  point to midnight of New Year’s Eve, December 2007, as the peak.    Another (comparably unsatisfactory) way of forcing the output data to cough up a precise month is to look at Personal Income, which is available monthly.   The BCDC’s computed measure of real personal income less transfers peaked in December 2007.  

      It would be wrong to claim that all roads arrive at the same destination, December 2007.   Other indicators point to other dates, some earlier, some later.  If we are very lucky, revisions that the BEA makes in July 2009 will help resolve the discrepancy between the GDP and GDI measures somewhere in the middle.  But perhaps the best characterization of the output measures is that they show a rough plateau from the fall of 2007 to the summer of 2008.   That the employment statistics speak more clearly allows them to have the predominant say.

Is the United States in recession?   If one looked solely at the adverse shocks that have hit the economy over the last year, one would infer an unusually high probability of a recession.    If one consulted some of the most import economic measures over the last year, one would say the country clearly entered a recession last January.  If one gauged the popular mood, one would hear, “Of course we are in recession !” 

The one criterion that has been missing is the one criterion that people most commonly have in their minds as the definition of a recession:   two consecutive quarters of negative growth.   This morning, October 30, the Commerce Department released the advance estimate of GDP for the 3^rd quarter.   It showed a decline.   The decline was small:  just 0.3 per cent at an annual rate; and it is only one quarter, not yet two.    But at this point there can be little doubt that we are really truly in recession. 

The adverse shocks include the most severe housing bust in more than 70 years, an oil shock as big as those of the 1970s, the greatest financial crisis since the Great Depression, and the worst fiscal outlook ever.    Any one of these developments would normally be enough to send an economy into recession.   Leading economists from Martin Feldstein to Larry Summers have been warning since the start of the year that the downturn has indeed arrived, not to mention Nouriel Roubini who forecast it far ahead of time.

And sure enough, many of the most reliable statistical indicators have suggested all year that we are in recession. 

The most important statistical criterion besides GDP is employment.   Jobs peaked in December 2007 and have declined steadily ever since.  The cumulative loss is 760 thousand (or 0.55%) as of September.    My personal favorite among indicators is Total Hours Worked in the economy, because it combines both employment (number of people working) and average length of workweek (are they working 40 hours a week? Overtime?  Part-time?).    Total Hours Worked shows a similar pattern as employment, but with an even steeper decline since December: 1.4%.  (The Bureau of Labor Statistics is the agency that releases these numbers, on the first Friday of the subsequent month.)

The index of Leading Economic Indicators, which is designed to try to warn of turning points in advance, turned down more than a year ago.   Not only that, but also the index of Coincident Economic Indicators, which is supposed to move contemporaneously with the real economy, appears clearly to indicate that a recession started toward the end of 2007.  

Housing prices as of August are down 27%, relative to their peak in July 2006 (Case-Shiller composite of 20 cities).   Consumer confidence, another important determinant of household spending, fell to an all-time low in September, according to the October 28 release from the Conference Board.  The version collected by the University of Michigan is also looking quite bleak.   Indeed, retail sales are down, especially autos.  The worse news in the Commerce Department report is that consumer spending took a steeper plunge in the third quarter than at any time in the last 28 years.   The trend in industrial production has been negative for a year, and accelerated in August and September.  Corporate profits are down too.

But it is still not yet officially a recession !  Why not?   The most important criterion for dating business cycles is real growth.    The rate of change of real GDP, surprisingly, was above zero in the first quarter of 2008, and was even moderately strong in the second quarter: 2.8%.   (The revised “final” estimate of GDP in the fourth quarter of 2007 did turn out to be below zero, but just barely.)     It is quite a mystery why output pointed up during the first half of the year, while everything else pointed down.  

Clearly the demand for US goods received some boost in the 2nd quarter from tax rebates and exports.   Exports continued to help growth in the third quarter (together with inventory investment, which probably includes some goods sitting on shelves that firms were unable to sell, and defense spending).    Net exports have been carrying the economy for the year, as one can readily tell by noting that real domestic purchases have been in decline.  Exports are unlikely to continue this role in the future, because our trading partners have slowed down more than we have and because the depreciation of the dollar has recently stopped.

But perhaps there is some measurement problem with GDP.   Gross National Income (GNI) has as much claim to measure growth as Gross National Product does.  In theory the two are supposed to be virtually the same: the value of goods and services sold is conceptually the same as the value of income earned.    Real GNI did in fact turn down in the 4th quarter of 2007 and the first quarter of 2008, though it rebounded in the third quarter as real output did.   Real personal income – one of the indicators that the NBER Business Cycle Dating Committee looks at – has been declining almost throughout the year. Real personal disposable income fell especially sharply in this morning’s release for the 3rd quarter.

The weight of evidence is now overwhelming:   we are currently in recession.

Did it start at the end of 2007, when employment and the other indicators peaked?     Or was the stimulus from the government and from exports enough to postpone the turning point, and did the recession thus only start towards the end of the summer, when the financial crisis intensified very sharply?   I am afraid that we need to wait for some more data and some more (regularly scheduled) revisions before we will know.

[For anyone wishing to comment on this post, I suggest you go to the RGE version.]

Over the past month, I , citing Feldstein, have said that if one looks at available information on monthly GDP, available from estimates of MacroAdvisers, that output declined within the first quarter of the year, even though as standardly reported GDP was higher in QI overall than it had been in the last quarter of 2007. But, as it turns out, there is some ambiguity to the question.

The estimates do show GDP falling in February, by a hefty 10.1% anualized. But the numbers for January and March are up. To net out the three months, one must split hairs. The positive numbers for January plus March are just slightly greater in absolute value than February’s negative 0.9 (monthly). So the net is up? Not necessarily.

We are trying to figure out the change within the quarter, from beginning to end. Technically, that means from January 1 to March 30. But of course even Macroadvisors doesn’t report daily or weekly estimates. Estimated total real GDP in the month of March was just slightly above total real GDP in the month of December. So again the net is up? The most precise measure of the change between January 1 to March 30 is the change between the December-January average and the March-April average. That is a tiny negative number: GDP fell by an estimated $28 billion within the first quarter (in year-2000 $). And April is so flat as to be essentially zero.

I think I am sorry I brought the subject up.

It would in any case be a mistake to make much of these numbers. The reason the Commerce Department’s Bureau of Economic Analysis doesn’t report monthly numbers is that the data are so unreliable, and subject to revision. For anyone who needs some sort of estimate of monthly GDP, as we do on the NBER Business Cycle Dating Committee as an input into our thinking, this is what we have to go on. But one sees here yet another illustration as to why the BCDC waits a long time, until all the data are in, before declaring a recession.

*** Comments can be posted at http://www.rgemonitor.com/us-monitor/bio/660/jeffrey_frankel . ***

The Commerce Department this morning revised upward its estimate of first quarter growth in real GDP to 0.9% (precisely in line with the expectations of economic forecasters).

As a member of the Business Cycle Dating Committee of the NBER, I am asked frequently if the country is about to enter a recession, or if we have already done so. I cannot speak for the Committee, and I am not a professional forecaster. But I can give my views, for what they are worth.

It is hard to say that we entered a recession in the early part of the year, without a single negative growth quarter, let alone two of them. Even so, three minor qualifications to that 0.9% remain:
1) The number will be revised again, and could move in either direction.
2) A bit of the measured growth consisted of an increased rate of inventory investment, which was almost certainly not desired by firms and is likely to reverse later in the year.
3) As Martin Feldstein has pointed out, the QI growth number is defined as the change for the quarter as a whole relative to QIV of 2007; within QI, the information currently available suggests that GDP fell from January to February to March.

The reason why many suspected a QI turning point in the first place is employment, which is virtually as important an indicator to the NBER BCDC as is GDP. Jobs have been lost each month since January. Total hours worked is my personal favorite, because in addition to employment it captures the length of the workweek, which firms tend to cut before they lay off workers. This indicator too has been falling.

And of course there are the longer run indicators that have been very worrisome for almost a year: depressed household balance sheets, mortgage defaults, high oil prices, low consumer confidence, etc.

The economy is a four-engine airplane flying at stall speed, skimming along the top of the waves without yet going down. Real gross domestic purchases increased only 0.1 percent in the first quarter — almost as flat as you can get. But net exports provided an important source of demand for US products, and are likely to remain a positive engine of growth in the future. The same is true of the fiscal policy engine, as consumers receive and spend their tax cuts in the 2^nd and 3^rd quarters. On the other wing, the investment engine has been knocked out; inventory investment is likely to fall and residential construction will remain negative for sometime. The big question mark is the consumption engine. Is the long-spending American household taking a hard look at its diminished net worth and taking steps to raise its saving rate above the very low levels of recent years? If so, a recession will ensue.

We are already clearly in a “growth recession.” All in all, I put the odds of an outright recession sometime this year at greater than 50%. That number is meant to add together:
(1) the odds that it will turn out that we have already passed the turning point and
(2) the odds that the sharp recent expansions in monetary and fiscal policy will succeed in postponing the recession, but only until later in the year.
Come the fall, if demand starts to slow, I can’t see either the Fed delivering a second big dose of interest rate cuts (as they were able to in the 2001 recession, when the dollar was strong and inflation under control), nor the government delivering a second big dose of tax cuts (as they could in the 2001 recession, when the budget outlook was strong and debt under control).

White House CEA Chairman Ed Lazear expressed confidence to the Wall Street Journal today that the country is not in recession. I, like Menzie Chinn, am surprised that Lazear is willing to put his reputation on the line in this way.

It is true that the Commerce Department BEA’s advanced estimate of first-quarter GDP growth was still above zero (+0.6%). But there are three reasons not to take this number too seriously.
(1) Revisions in these numbers are usually substantial, so the final number could easily turn out to be negative — or twice as high.
(2) Even if the +0.6% number were to hold up, it can be entirely accounted for by measured inventory investment. In other words, real final demand fell rather than rose in the first quarter. It is plain that this inventory accumulation was not the outcome of deliberate decisions by bullish firms to add to their inventories in anticipation of a booming economy. Rather it was almost certainly unintended inventory accumulation, as goods sat unsold on store shelves and in warehouses. This overhang makes it more likely that inventory accumulation will be negative in the 2nd quarter. (Admittedly, rising exports from the weak dollar and rising consumption from the tax rebate checks could outweigh that particular factor, and we could scrape along the ground for another quarter at near-zero growth).
(3) As Martin Feldstein has been pointing out (e.g., in the FT), it is a misinterpretation of the GDP statistics to say that growth remained positive in the first quarter. Rather GDP for QI as a whole was estimated to have been 0.6% higher as compared to QIV as a whole. The Commerce Department does not report monthly GDP estimates, but MacroAdvisers does, and these data suggest that monthly GDP has been declining since January.

There are other reasons as well to consider it likely that a recession may have started as early as January. The NBER Business Cycle Dating Committee, which declares when recessions start, looks at lots of data. But the most important information, alongside GDP, is the jobs data from the Bureau of Labor Statistics. Employment, like GDP, offers a comprehensive measure across the economy, but it has the advantage of being available monthly and with shorter lags. The employment data suggest that the recession may have started in January.

It is certainly possible that it will turn out, in the end, that the economy escaped recession in the first quarter. Even if that is the case, however, it is difficult to be optimistic about the rest of the year. I can’t remember a time when there have been so many worrisome danger signals: depressed household balance sheets, mortgage defaults, high oil prices, low consumer confidence, … . The odds of a recession sometime this year must be rated high.

Fed Chairman Bernanke and Treasury Secretary Paulson have wisely reined in the “happy talk” with which the initial sub-prime mortgage crisis was greeted last year. (Remember “the crisis looks contained”?) If I were Ed Lazear, I would follow their lead.