The Next Recession Is Coming
June 8, 2015
A week ago Friday at 8:30 a.m. EDT, the global economy received bracing news. The U.S. Bureau of Economic Analysis announced, according to its second of three estimates, that U.S. gross domestic product contracted at an annualized rate of 0.7 percent. BEA’s first (or “advance”) estimate had been a slight 0.2 percent annualized increase in first-quarter GDP. When confronted with data updates like this, we hear two common questions: Why do government data get revised like this? And what might a one-quarter contraction in GDP foretell?
Take the statistical question first. In today’s hyper-connected world, where real-time data on countless items can be instantly accessed on the Internet, how can it be that on April 29 the U.S. government reported that GDP expanded a bit—and then just one month later updated that the slight expansion was actually a noticeable contraction, with the size of the swing nearly a full percentage point (annualized)? Is this some sort of insidious handiwork by Edward Snowden?
No, the explanation is something much more prosaic. With U.S. GDP last year totaling $17.4 trillion, tracking data on the entirety of the economy takes both massive resources and a fair bit of time. Take trade, for example. U.S. exports and imports of goods and services cross the U.S. border at thousands of entry points, at a total last year of over $5.2 trillion in value. Each time the BEA issues its advance GDP estimate for a quarter, it does not have trade data for at least the third month in question. So, embodied in each advance estimate is a projection. In the month between the advance and second estimate, more trade data arrives that can bump up or down the earlier GDP estimate. In this instance, in early May new data arrived showing a fall in U.S. exports and a surge in U.S. imports that helped pull down GDP.
(Editorial aside: If you would like the U.S. government to collect more and more-timely data, then be willing to pay more in taxes to fund statistical agencies like the BEA. We both have long worked with the dedicated public servants at these agencies, and most of their leaders and staff are earnest professionals whose main challenge is inadequate and volatile funding.)
What about the economic importance of GDP contracting in the first quarter? Much of the analysis purred that one-off first-quarter problems—such as the brutal winter and the West Coast ports strike—have faded to allow the U.S. economy to resume growing. Maybe, and we hope so. But to support your critical-thinking skills this Monday morning, we encourage you to ponder for a moment the alternative: that the next recession is coming.
There is no universal definition of recessions. Many contend that two (or more) consecutive quarters of contracting GDP constitutes a recession. In the United States, most defer to a different authority: the Business Cycle Dating Committee of the National Bureau of Economic Research, “the nation’s leading nonprofit economic research organization.” The Committee dates recessions using a broader set of criteria: not just GDP but also employment and income.
The current U.S. economic expansion that, according to the NBER, began in June 2009 is now 73 months old. Of the 11 previous expansions since World War II, the average length was 58.4 months. Only three were longer than 73 months, and the longest ran 120 months.
Why do expansions give way to contractions? Often they are induced by central banks aiming to curb inflation. When aggregate demand expands too quickly relative to aggregate supply, price inflation tends to accelerate. Central banks charged with controlling inflation then tighten monetary policy, contracting in some combination demand by households and businesses and thus driving down output as well. Perhaps the most famous example of this Fed-induced recession was Paul Volcker’s “attack on inflation.” Periods of strong productivity growth tend to be less prone to recessions. Thus, for example, did America achieve that 120-month expansion from March 1991 to March 2001 in large part because of the productivity boom driven by information technology (about which we have written here).
So where does that leave us today? History suggests that the current economic expansion is well past middle age. Janet Yellen and many other Fed leaders are telegraphing interest-rate increases before too long. U.S. productivity growth has worrisomely decelerated in recent years and, for the first time since 2006, it has declined for the past two quarters. Recessions are notoriously difficult to predict. Economists predict poorly many things, but high on this list is turns in the business cycle. This is partly because there are no consistently reliable recession signals. Nobel Laureate Paul Samuelson once quipped that, “Wall Street indexes predicted nine out of the last five recessions.” Unexpected though they are, recessions always come. At some point, you should think about getting ready.
Articles © 2015 Matthew Slaughter and Matthew Rees. All rights reserved.
Publication © 2015 Trustees of Dartmouth College. All rights reserved.