Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. He was a member of the NBER’s Business Cycle Dating Committee for 25 years, with his term ending last fall. A shorter version appeared in Project Syndicate and in The Guardian.
The Business Cycle Dating Committee of the National Bureau of Economic Research declared on June 9 that US economic activity had peaked in February 2020, formally marking the start of the recession.
We all knew about the recession already and even the likely date when it started. Looking at the numbers gave the same answer as “looking out the window.” Measures of employment had fallen sharply from February to March. Real personal consumption expenditures (PCE) and real personal income less transfers (which are numbers that the NBER Committee looks at) both peaked sharply in February as well. Official measures of GDP only exist on a quarterly basis; but the economic freefall in late March was enough to pull first-quarter GDP growth down to an annual rate of -4.8 % (relative to the last quarter of 2019). Why did the NBER wait until now to declare something that had already been so clear?
Two critiques of the NBER Committee
Every time the NBER Committee declares a cyclical turning point, many react along the lines, “What took it so long?” As it happens the 4-month lag between the event and the declaration last week was the shortest lag since the Committee was constituted in 1978. The average lag across the 10 turning points since 1980 had been 11.7 months. The shortest lag had been 6 months. The relative speediness this time is testament to the history-making suddenness of the pandemic-induced drop-off.
An equally common public reaction is skepticism — and often surprise — that the declaration of US recessions is left to the judgment of a panel of economists based on a variety of indicators. “I thought a recession was defined as two negative quarters of GDP growth.” The US is not quite the only country that does it this way. The Japanese government also departs from the automatic two-quarter rule and considers other indicators in its official business cycle chronology. But it is true that almost all other advanced countries use the two-quarter rule.
The US is unusual in that the NBER is a private (non-profit) research institution. But the NBER chronology does have official status, as confirmed on the website of the Bureau of Economic Analysis of the US Department of Commerce. [“The designation of a recession is the province of a committee of experts at the National Bureau of Economic Research (NBER), a private non-profit research organization.”] Private committees in some other countries date business cycles by looking at a variety of economic indicators, including the eurozone, Canada, Spain and Brazil. But their decisions receive less attention from the media or official government bodies.
It is useful that everyone works off of a common officially designated chronology. Whether it is an econometric scholar doing macroeconomic research or a politician giving a speech that tries to assign credit or blame for a recession, they use the NBER dates.
It is important to note that the two critiques — “why the lag?” and “why not the two-quarter rule?” — tend to be at odds with each other. GDP statistics are only gathered with a lag and are always revised subsequently, particularly the following July. Waiting for the definitive GDP numbers would sometimes require an even longer lag between the actual start of the recession and its official designation.
3 examples show the difference in procedures
The recent NBER declaration of the coronavirus recession is an example of how it helps to be free of the GDP rule. Forecasts say that the second quarter of 2020 will show another plunge in US output (perhaps 30-40 % when annualized), much bigger than the fall in the first quarter. Nevertheless, the second negative quarter will not be verified until the July 30 release by the Commerce Department’s Bureau of Economic Analysis. And even that number will only be the “advanced estimate.”
Another example of how much difference it makes: nobody questions the NBER ruling that there was a recession in 2001, even though the two quarters of negative GDP growth that year were not consecutive. (That is going by the conventionally-reported output-side measure of GDP. The NBER pays equal attention to the little-known income-side measure of GDP.) As a corollary, everyone accepts that the longest US expansion on record until recently was the 10-year period (120 months) from March 1991 to March 2001. Nobody tries to claim that because 2001 did not meet the criterion of two consecutive negative quarters, the record length of a US expansion is in fact the period of 201 months from March 1991 to December 2007. That would be consequential: it would deprive the just-completed 128-month expansion (from June 2009 to February 2020) of its title as the longest recorded expansion in US history.
A third example: at the time when the NBER committee announced that (what came to be called) the “Great Recession” had begun with a peak in December 2007, the government estimates still reported that the official GDP measure was actually higher in both the first and second quarters of 2008 than the last quarter of 2007. Even though the announcement of the beginning of the recession was greeted as long overdue, the Committee would have had to wait another year and a half to get that crucial revision from the Commerce Department if it had applied the “two quarters of negative growth” rule.
Pros and cons
The two-quarter rule has both pros and cons compared to the NBER committee’s less mechanical approach. One advantage is that it appears more objective to have an automatic procedure that is simple and transparent, especially if the alternative is delegating the job to a committee of unelected unaccountable ivory-tower economists.
One major disadvantage of the two-quarter rule is that when the GDP statistics are revised subsequently, they may require a retroactive revision of the cyclical turning points. For example, a 2011-12 recession in the United Kingdom was subsequently erased from the record when the GDP numbers were revised in 2013. Claims that in 2012 had appeared in the speeches of UK politicians and in the writings of researchers, made in good faith at the time, were subsequently rendered false.
Another disadvantage of using the rule of two consecutive quarters is that a single big long downturn can be recorded as multiple short recessions if it is interrupted by slight up-ticks. Examples include Ireland, Finland and Italy in the aftermath of the global financial crisis. The NBER waits until GDP has re-attained its preceding peak, or at least come close, before judging that a recession has ended.
This point could become an issue in the US and many other countries later in the 2020 recession. As the coronavirus shut down the economy in March-April, the plunge left economic activity at levels far below where they were in 2019. Some countries will have a positive 3rd quarter, which would put an end to their recessions according to the two-quarter rule. Yet this will strike most people as the wrong answer, because the levels of GDP and employment are likely to remain far below their pre-pandemic levels. This is especially true if the positive quarter is followed by a renewed downturn, as in the famous “W” scenario, which is all-too-likely.
The NBER waits before dating a trough or peak until it can be reasonably sure it will not have to revise the call in the future, after the dates have already entered the official chronology. The Committee would revise a date if it had to, and has occasionally considered it. But a revision of dates would be confusing. And the Committee has never done it. Hundreds of other observers try to assess the odds of a recession like the current one in real time. The NBER committee sees its job, not as being the fastest, but as being definitive.
This post written by Jeffrey Frankel.