Are we in a recession? If you think you know the answer, you’re only partly right
In mid-July, inflation hit yet another 40 year high at 9.1% over the past 12 months.
The Federal Reserve has made it abundantly clear that they will raise interest rates until that inflation number comes down.
It would be unusual for the inflation rate to come down from the Fed is tightening monetary policy without experiencing a recession. So it’s no surprise that recession talk has heated up in the past few months. Everyone seems to be on recession watch, even my wife.
She recently asked me, “How do you even define what a recession actually is.”
Giving her a good definition was harder than it sounds at first blush. Most people in the world of finance assume a recession is when real GDP contracts for two consecutive quarters. This is a simple definition that makes a lot of sense, even to those of us who aren’t economists.
The problem is, this definition hasn’t been fulfilled in two out of the last three recessions. The 2020 recession was the fastest in history, lasting just two months, not two quarters. And in the brief 2001 recession real GDP didn’t contract for two quarters in a row either.
That’s because recessions are officially determined by a group of economists at the National Bureau of Economics (NBER) and they use a host of measures beyond real GDP to make it official.
Here’s how NBER describes their Business Cycle Dating criteria:
The NBER’s definition emphasizes that a recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months. In our interpretation of this definition, we treat the three criteria—depth, diffusion, and duration—as somewhat interchangeable.
The determination of the months of peaks and troughs is based on a range of monthly measures of aggregate real economic activity published by the federal statistical agencies. These include real personal income less transfers, nonfarm payroll employment, employment as measured by the household survey, real personal consumption expenditures, wholesale-retail sales adjusted for price changes, and industrial production. There is no fixed rule about what measures contribute information to the process or how they are weighted in our decisions. In recent decades, the two measures we have put the most weight on are real personal income less transfers and nonfarm payroll employment.
That’s a mouthful but we can basically boil it down to income and employment. If income and employment turn south, there’s a good chance economic output will be lower.
The strange thing about the current setup is output is slowing but income and the labor market are still solid. Real GDP was down in the first quarter of the year. There is a good possibility it will also be down in the second quarter.
While economic output is slowing, the labor market remains strong. U.S. households earned more than ever through the end of May, even after accounting for inflation.
Before the pandemic, the lowest layoff rate ever was 1.1%. It’s now been lower than that for more than a year:
And this is happening at a time when the quits rate is higher than at any point pre-pandemic:
Millions of people feel confident enough in their finances or ability to find a new job that they are willingly quitting their current roles. And workers are getting laid off at some of the lowest rates ever. These are signs of a healthy labor market.
The unemployment rate also remains low at just 3.6%. The U.S. economy added 1.6 million jobs in the first quarter of this year. Another 1.1 million jobs were added in the second quarter.
Those numbers don’t look recessionary to me.
Now, it’s possible personal income and unemployment data will soften in the coming months from some combination of the Fed raising interest rates and inflation remaining stubbornly high.
But it’s also increasingly likely we could see real GDP contract while these measures remain strong. And if that happens, certain people are going to lose their minds. Some people want to be right about a recession prediction. Some people in finance are pessimistic by nature. Some people think the system is rigged. Some people just want to watch the world burn.
Here’s the thing — it doesn’t really matter to most regular people if real GDP falls two quarters in a row but NBER doesn’t label it an official recession. Policy wonks, macro tourists and markets people like me who find this stuff interesting will care but the only thing that matters to normal people is their own personal economy.
There’s the old saying that a recession is when your neighbors lose their job while a depression is when you lose your job.
If you get laid off in the coming months it doesn’t matter what some council of economists says about the economy. You’re going to feel it, emotionally and financially. Losing your job is a personal recession no matter when it takes place in the economic cycle.
And even if we do go into the official definition of a recession, if you’re able to hold onto your job, keep saving money and avoid working in a segment of the economy that gets hammered, it won’t really feel like a recession to you personally.
Unemployment rates, inflation rates, personal income averages, savings rates and all kinds of other economic data can do a decent job of helping understand trends in the economy in the aggregate.
Yet no individual or household is representative of those averages. We all have our own unique preferences, spending habits, finances and circumstances.
It may seem like splitting hairs to argue about the definition of a recession but I just want to prepare you for a potentially bizarre economic scenario in the months ahead where some people will argue we’re in a recession while others will refute that idea vigorously.
Prepare yourself for the economy to get even weirder.
Certain securities mentioned in the article may be currently held, have been held, or may be held in the future in the author’s personal portfolio or a portfolio managed by Ritholtz Wealth Management.
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