This past week, the Bureau of Economic Analysis announced that the gross domestic product (GDP), which is a frequently used measure for economic growth, declined 0.9 percent in the second quarter of 2022. In the first quarter of 2022, the GDP decreased by 1.6 percent. According to the BEA, the reasons for the decline in real GDP include decreases in private inventory investment, residential fixed investment, federal government spending, state and local government spendings and nonresidential fixed investment that were partly offset by increases in exports and imports." Why does this bit of economic news matter? Because two quarters of negative GDP growth is a widely regarded rule of thumb to indicate that the economy is in a recession.
In response to the news about the GDP, the Biden administration flatly denied in a press release last Thursday that we are in a recession. I could understand why Biden would want to make such a claim. There is a decidedly political element to such a reaction. The United States is in an election cycle with about three months until the midterm elections. Things have not been going great since Biden entered the White House. Even the Biden administration's overreacting to COVID notwithstanding, inflation started rising to a 40-year high shortly after Biden entered the White House (more on that later). There is a war going on in Ukraine. Crime has been rising across the country. There is a baby formula shortage that has not abated. Now there is concern over monkeypox. There is no shortage of issues and challenges that face the White House. One of the last things Democrats want to deal with right now is the "r-word." It would also explain why the Republicans are all too keen to declare this a recession. So are we in a recession or not?
We want an answer now because politics are driving us to answer the question. Even so, the answer to that is trickier than one might think. Since 1948, an organization called the National Bureau of Economic Research (NBER) has been dubbed the arbiter of declaring when a recession takes place. NBER looks at more than whether there are two quarters of GDP decline. With the GDP itself, it also looks at the depth and diffusion of the economic downturn. As for other metrics, NBER also takes into account such factors as employment, personal income, and industrial production. GDP should be a metric, but not the only one.
The incompleteness of the GDP is a concept I understand. In 2014, I criticized the GDP as a metric. Although I said it was still the best single metric we had, I did point out its obvious limits. The GDP is an imperfect but still widely used measure. NBER waits a bit longer to collect more data before declaring a recession, which means if it declares a recession, it most probably will not happen before the elections. Even so, every time since 1948 that there has been two quarters of GDP decline, NBER has declared a recession. Also, the Gramm-Rudman-Hollings Act of 1985 includes a clause that defines a recession as two quarters of declining GDP. The reason I bring this Act up is because it is not an academic debate or an argument over semantics. This Act is important because the recession clause has been used subsequently in other legislation to enact measures that determine policy during a recession. If that were not enough, Biden's economic adviser Jared Bernstein admitted in 2019 that a recession includes two quarters of GDP decline, as did the Washington Post in 2015.
The response to the pandemic, which included unprecedentedly expansionary monetary and fiscal policy, created such unusual economic conditions that wading through macroeconomic indicators can be a challenge. Plus, macroeconomics has many moving parts with multiple indicators (see AIER's Leading Indicators Index to give you an idea). Nevertheless, I want to give it a go at looking at some main macroeconomic indicators beyond the GDP.
Let's start with job growth since it was a point that Treasury Secretary Janet Yellen brought up. Job growth has averaged at around 400,000 jobs for the past year, according to Bureau of Labor Statistics (BLS) data (see below; figures are in thousands). For Yellen, a recession is a "broad-based weakness in the economy," which is not something that would take place if job growth were at the rate it is. Yellen does have a point in the sense that recessions typically perpetuate unemployment. As unemployment rises, demand and output decrease. With more unemployed people and fewer jobs, that would mean less work and money to spend.
Thankfully, that is not the situation we have. While job openings have slightly dropped (BLS), there are still about two job openings for each unemployed person in the U.S. The main issue with using unemployment as a predictor is because those sorts of job losses happen mid-recession (i.e., unemployment is a lagging indicator). Plus, we should also consider that there have been recessions that have had growing or stabilized payroll employment numbers, including December 2007 to March 2008; January to April 1980; November 1973 to October 1974; and December 1969 to April 1970.
.png)
At least in U.S. terms, inflation has been off the charts. The United States has experienced 8.6 percent inflation over year in May 2022 (BLS), a rate that we have not seen since the 1970s. Even when you remove food and energy from the Consumer Price Index (CPI), the numbers are far from flattering. To combat the high inflation, the Federal Reserve is raising interest rates. Part of raising interest rates is that it makes borrowing money more expensive. As such, a potential downside of raising the interest rates too quickly is the increased likelihood of a recession.
I have to wonder about some consumption and production metrics. On the one hand, durable goods orders is a good indicator of whether the manufacturing sector is doing well. Based on FRED data, durable goods orders are still increasing.
On the other hand, consumer sentiment is sinking. The University of Michigan Survey of Consumers has been measuring consumer sentiment since the 1960s. As you can see below (grey indicates recessionary period), a downward trend in consumer sentiment commonly indicates that we are heading into a recession. The reason for this is not because of clairvoyance but because having a large sample size to determine how consumers feel like spending provides a good proxy for economic conditions.
The Left-leaning Economic Policy Institute brings up a point about consumption that could mitigate the Consumer Sentiment Index. Per EPI's argument, a better metric than GDP would be domestic demand growth (also known as final sales to domestic producers). This metric measures spending from consumers, businesses, and the government that filters out inventory volatility. By this metric, only the second quarter was an issue because there was a plateau in Q2 (FRED). My reply to that argument is that as is illustrated by the data below, this metric does not do a good job of acting as a leading indicator of a recession.
If you feel like sidestepping the argument above, how about taking a look at the yield curve? A yield curve is a comparison of interest rates for short-term and long-term debt instruments, normally bonds. There are times when the short-term rates rise above long-term ones. However, if that temporary blip turns into a curve that is known as an inversion, that is taken as a signal that the economy is not doing well. As I pointed out in 2018 in my primer on yield curves, an inverted yield curve has predicted every recession in the past 60 years. What makes an inverted yield curve scary is its predictive power. And guess what? As the New York Times points out, we are in the middle of an inverted yield curve right now.
The last metric I want to cover is the Leading Economic Index (LEI). The LEI is created by the nonprofit association called The Conference Board, who mainly serves Fortune 500 clients. The LEI takes into account multiple factors, including GDP, unemployment, yield curve, manufacturing, retail, stock prices, and unemployment claims. A rising LEI score indicates the economy is faring well, whereas a falling score indicates worsening conditions. According to its latest LEI press release, the LEI is going downward, which indicates that the economy is getting worse.
While some of the indicators deliver a mixed picture, there are enough macroeconomic trends that are worrisome. We are certainly in a stage of economic decline, no question about that. Whether it ends up technically being a recession, even if brief and shallow, is something that time will be able to tell. What I find most problematic is that there are three strong indicators that are signaling a recession: declining GDP, a decrease in consumer sentiment, and an inverted yield curve. These indicators make me inclined to think we are most likely either in a recession or that we are well on our way to being in a recession.
Regardless of the ink being spilled over the quibbling of the definition of "recession," you don't need a thermometer to know that it's hot outside, much like you don't need an advanced degree in economics or public policy to know that there is something awry with the economy. A CNN poll a couple of weeks ago found that 64 percent of Americans believe we are in a recession, which included 56 percent of Democrats. Whether you call it a recession or not, what matters is that Americans are hurting financially and they know it. Unless the Biden administration can come up with some actual policy solutions instead of partaking in semantic sophistry, the state of the economy is going to be on many voters' minds and not in a way favorable to the powers that be.
No comments:
Post a Comment