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.)

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                                                              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

 

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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.

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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.

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Payroll employment peaked in December, and according to numbers released today had declined by 260,000 jobs as of April. (Source: BLS.) Since we have not yet seen a single negative number on GDP growth, this job loss is easily the most tangible statistical evidence we have so far that the much-heralded recession indeed may have started in the first quarter of 2008.

It has been noted that the unemployment rate started out from a low level — averaging 4.6 % in 2007 — so that even after a period of gradual increase, it remains relatively low by historical standards: 5.0% in April. This is still inside the range that has usually been considered by politicians as too low to generate serious discontent (and by central bankers as too low to put downward pressure on wages and prices). But why, then, is there so much popular dissatisfaction with the economy?

One answer is the old “discouraged worker” effect. Workers who stop looking for a job are not counted in the labor force, and so are not counted as unemployed. There is an obvious way to capture this phenomenon. Compare employment to the entire population, rather than only to those who are actively in the work force. The chart does that. (These figures include farm jobs, as in the standard BLS employment ratio.)

The path of the employment/population ratio during the current decade has been remarkable. The steep slide in jobs that began with the 2001 recession continued thereafter, and actually accelerated in late 2002. Finally the freefall leveled out. (The Bush Administration trumpeted the turnabout in terms similar to those it now uses to sell the aftermath of the troop surge in Iraq: the response to an unacceptable casualty rate was to make things worse for a half-year, and thereafter to compare the post-surge rate of casualties to the high-point, rather than to the period that came before.)

Employment did indeed rise between the years 2003 and 2007. But it barely stayed ahead of population growth. It did very little to make up for the decline equal to 2-3% of the population that had taken place during the first two years of the Bush Administration. The labor force participation rate normally rises in a boom, as good labor market conditions lure workers out of homes, schools and retirement. This is certainly what happened during the record expansion of 1992-2000. But it did not happen during the most recent expansion. To the contrary, the labor force participation rate was at a minimum in 2007, even though that year appears to have been the peak of the business cycle. As a result, employment as a share of the population was well below what it had been at the preceding business cycle peak year (2000). The fraction of Americans with jobs shows a decline from 64.7% to 62.6%, which translates into 4.9 million missing jobs ! Little wonder that, as employment once again starts to decline even in absolute terms, workers are unhappy.