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Econographics July 28, 2022

When does an economy enter recession?

By Charles Lichfield, Sophia Busch

If we followed the same rules as our economic partners, today’s disappointing news that the US economy contracted in Q2 would have tipped us into recession. Q1 registered a 1.6% contraction (in annualized rates) so Q2’s 0.9% contraction makes for two successive quarters of negative GDP growth.

Rigid definitions have their downsides.

First, those who remember the European chapter of the Global Financial Crisis will be all too familiar with double-dip recessions, which, in many ways, are just long downturns.

Second, using a more flexible and complex definition of recessions gives the US more time to prepare. In May 2021, Andrew C. Eggers, Martin Ellison and Sang Seok Lee showed that official news of a recession makes consumer confidence fall faster. There are also statistically significant effects on consumption and ultimate GDP levels over a wide panel of countries.

Still, we shouldn’t hide behind the definition either. In its July update to the World Economic Outlook, the IMF already raises the alarm, revising its baseline forecast for global growth in 2022 down 0.4 percentage points to 3.2 percent. Almost any developed economy would be delighted if such a projection were to concern its growth alone. But predictably developed economies including the US are the most likely to register sub-zero growth this year.

Always keen to dig deeper into the current numbers and historical precedent, the GeoEconomics Center took a look at how and when major economies tipped into previous recessions. The main phenomenon which sets this new downturn apart: tight labor markets.

Recession retrospective

The textbook definition of a recession – two consecutive quarters of sub-zero GDP growth – presents the obvious flaw of declaring any recession over as soon as a slight rebound takes place, even if this fits within a prolonged downturn. The UK and the Euro Area experienced “double dip” recessions during the GFC, as we have seen. This happened again during the Covid-19 pandemic.

The US stands out among major economies in using a softer, more flexible definition of a recession. The National Bureau of Economic Research defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” With no fixed timing rule, determining recessions in the past has taken anywhere between four and 21 months. Nor is there any fixed rule on what indicators (from real person income less transfers to industrial production) contribute toward the process or how they are weighted.

China, which famously bucked the recession trend in 2008-09, releases quarterly GDP data. The still-noticeable effects of the Covid-19 pandemic may not yet have caused a traditional recession in China, but it’s clear the government doesn’t want to establish an official procedure to acknowledge a recession as trumpeting growth is a key part of the social contract.

What’s different this time?

The recessions experienced by the United States since 2000 have had different causes but were united, until now, in their noticeably negative effect on the labor market.

In this potential recession, we are seeing the near opposite effect, with the number of unemployed per vacancy at an all-time low.

Does the Biden White House have a point when it emphasizes the tight labor market to calm fears of a recession? Yes and no. The figures speak for themselves, as you can see in the chart. But workers’ bargaining power can only achieve so much in an environment of high inflation driven by supply shocks and employers anticipating lower revenue. So even in a tight labor market, workers will very much feel the effects of this recession, if it happens.

On the other hand, the tight labor market may well provide the NBER with an argument to push back its recession call. After all, employment as measured by the household survey is another indicator used for the assessment. It just so happens that most of the other indicators are pointing in the other direction.

Charles Lichfield is Deputy Director of the GeoEconomics Center.
Sophia Busch is a Program Assistant with the GeoEconomics Center.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.

Related Experts: Charles Lichfield and Sophia Busch

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