With recession calls becoming more frequent (, , , , ) it might pay to revisit the indicators that the NBER looks at in determining the turning points in recessions (The fact that NBER put up some new recession-dating-FAQs just a couple days ago might be a leading indicator of sorts).
Figure 1: Posts on “recessions” by weblogs with “any authority”, accessed on January 9, 2008. Source: Technorati.
First, let’s recall what the various definitions of a recession are. The oft-cited two consecutive quarters of negative real GDP growth indicator is a rule-of-thumb. In the United States, the standard arbiter is the NBER business cycle dating committee (or, as it’s now brought to my attention, the “BCDC”), although the authors of the 2004 Economic Report of the President made the argument for a different timing than the NBER arrived at (see this post on that debate).
From the 2003 report:
“In choosing the dates of business-cycle turning points, the committee follows standard procedures to assure continuity in the chronology. Because a recession influences the economy broadly and is not confined to one sector, the committee emphasizes economy-wide measures of economic activity. The committee views real GDP as the single best measure of aggregate economic activity. In determining whether a recession has occurred and in identifying the approximate dates of the peak and the trough, the committee therefore places considerable weight on the estimates of real GDP issued by the Bureau of Economic Analysis of the U.S. Department of Commerce. The traditional role of the committee is to maintain a monthly chronology, however, and the BEA’s real GDP estimates are only available quarterly. For this reason, the committee refers to a variety of monthly indicators to determine the months of peaks and troughs.
The committee places particular emphasis on two monthly measures of activity across the entire economy: (1) personal income less transfer payments, in real terms and (2) employment. In addition, the committee refers to two indicators with coverage primarily of manufacturing and goods: (3) industrial production and (4) the volume of sales of the manufacturing and wholesale-retail sectors adjusted for price changes. The committee also looks at monthly estimates of real GDP such as those prepared by Macroeconomic Advisers (see http://www.macroadvisers.com). Although these indicators are the most important measures considered by the NBER in developing its business cycle chronology, there is no fixed rule about which other measures contribute information to the process.”
The Indicators to Date
Armed with this information, let’s examine the various series. Figure 2 depicts the first two series (both in logs). It’s clear that real personal income has plateaued, if not started to decline — although we do not have December figures. Payroll employment growth has slowed to a crawl.
Figure 2: Log personal income less transfers in 2000Ch.$ (blue) and log payroll employment. Real personal income calculated by subtracting off transfers from personal income, and deflating by the personal consumption expenditure deflator. Source: BEA and St. Louis Fed FRED II.
As has been discussed at length, the BLS firm Birth/Death model seems to lead to overprediction around negative turning points and underprediction around positive turning points. Hence, in Figure 3, I plot both the establishment series (red) and the household series adjusted to conform to the payroll concept (green).
Figure 3: Log payroll employment (red) and log household civilian employment, adjusted to conform to payroll definition (green). Source: St. Louis Fed FRED II and BLS.
In my view, the household series does not provide much solace to those who believe a recession can be avoided.
The next figure (figure 4) depicts industrial production (blue) and real manufacturing and trade sales (red) (both in logs); here the trends are more mixed, although we do not have the November data for the latter series (as noted in this post, industrial production looks like it’s peaked, although it’s conceivable this is just a local maximum).
Figure 4: Log industrial production (blue) and log manufacturing and trade sales, in Ch.2000$. Source: Federal Reserve Board via St. Louis Fed FRED II, and BEA.
The final indicator, mentioned as an adjunct series, is Macroeconomic Advisers’ monthly GDP series. I don’t have access to that series, but have e-forecasting.com‘s series. From the January 4th newsletter, here’s the level of GDP estimate for December.
Figure 5: Monthly real GDP (Ch.2000$). Source: e-forecasting.com.
Output appears to be stabilizing as well, although I do not have documentation for how this series relates to the Macroeconomic Advisers series.
Will the rest of the world save the US economy? Well, e-forecasting‘s index of leading indicators (January 2 newsletter; documentation here), besides indicating a 81% probability of recession, incorporates a large negative effect coming from the foreign demand component. This has been described to me as being based on incoming orders of manufactured goods coming from foreign countries.
Figure 6: Components of the e-forecasting eLEI. Source: e-forecasting.com.
Not good news for the decoupling hypothesis. This is consistent with my earlier skepticism regarding the decoupling hypothesis, and ambivalence regarding whether net export growth could prevent the US economy from going into recession.
Are the Policies of the Past Responsible for the (Potential) Recession of the Present?
One could plausibly say the two recession characterization is unfair, even if technically this is the outcome in the end. After all, the recession that the NBER dates as beginning in March of 2001 is unlikely to have arisen as a consequence of policies (either actual or anticipated) with the Bush Administration. But if we slide into recession in 2008, all I can say is that — despite the talk about fiscal and monetary policy — our actions are constrained by the profligacy of the two Bush tax cuts and the (domestic) spending binge.
To recap what I wrote in October 2006:
The current episode is distinguished from previous ones by a set of constraints on policy that did not exist before 2001. First, using fiscal policy — aside from automatic stabilizers — is much less plausible than it was at the beginning of the last recession in March 2001. As many recall, before the implementation of the Economic Growth and Tax Relief Reconciliation Act of 2001, the Congressional Budget Office was projecting enormous surpluses as far as the eye could see. Even if in hindsight some of those projected revenues were unlikely to materialize because of the transitory nature of the stock options phenomenon, there is no denying that the budget surplus was slightly over 1% of GDP in fiscal year 2001, while in fiscal year 2006, with the economy running at near full employment, the budget deficit is projected to be around 2%. Furthermore, the deficit is likely to rise even if the economy maintains growth at consensus rates. But it’s not only the budget deficit that places constraints on discretionary fiscal policy. The stock of Federal debt held by the public has increased enormously, from $3.3 trillion to a projected $5.6 trillion (end of fiscal years), at exactly the same time that the prospect for even greater funding requirements for entitlements looms on the near horizon. The addition of an enormous new prescription drug entitlement (officially called Medicare Part D) only worsened the long term fiscal position of the U.S. Government. Indeed, GAO estimates that this single provision added $8.7 trillion dollars worth of contingent liabilities to the Federal government’s exposure, fully 50% larger than the estimated Social Security exposure. Hence, borrowing for expansionary fiscal policies — either tax cuts or increased transfers — may encounter weaker demand on the part of foreigners, as well as domestic residents, as these future borrowing needs loom. This in turn means that expansionary effect of budget deficits may be much smaller and costlier at exactly the time that we need the help of fiscal policy.
What about monetary policy? It is an economic truism that you cannot hit two separate target variables with one instrument. With fiscal policy hamstrung, monetary policy needs to make tradeoffs in order to hit inflation and output targets. If energy prices continue their slide, it may be that monetary policymakers will have the leeway to drop the Fed Funds rate. But if, for instance, energy prices do not continue their fall, or a decline in the dollar’s value leads to a rise in import prices, then the Fed will be forced to choose between inflation stabilization and output stabilization. With Ben Bernanke at the helm, I think I know on which side he would err.
In fact, the choice may be more painful than what I have suggested in this scenario. In the wake of the dot-com collapse, monetary policy was successful in spurring economic recovery by encouraging a massive boom in residential investment. With the [nominal] stock of housing at the end of  45% larger than it was at the end of 2000, it is not clear that a repeat performance is possible. [editorial changes made, in brackets]
These are points to keep in mind as the Administration and Congress consider ways of stimulating the economy (see e.g., this article).
In addition, it is becoming increasingly apparent that the Administration’s laissez faire (that’s the charitable interpretation, see here and here) approach to mortgage market regulation led at least in part to the unsustainable boom in housing markets. The hangover from this boom-bust cycle will likely be with us for a long time; it remains to be seen if we will avoid incurring large fiscal liabilities that would arise from large scale failures of financial institutions.
In this sense, I think a lot of the blame for the depth and persistence of this incipient slowdown will be attributable to the policies of the Administration.
[late addition: 1/10/08, 10:35am Pacific]
Figure 7: Consumer debt to GDP ratio. Source: CMDEBT series from St. Louis Fed FRED II, BEA, and author’s calculations.