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What is a recession?: Feature Article

What is a recession?

According to macroeconomics a recession is a decline in a country's real gross domestic product or negative real economic growth for two or more successive quarters of a year, so basically for half of the year or more. In fact a recession can actually involve simultaneous declines in coincident measures of overall economic activity including employment, investment, and corporate profits. But recessions are also associated with falling prices, which is also referred to as deflation. But a recession can also be associated with sharply rising prices, which is called inflation, as long as these sharply rising prices are in a process known as stagflation. If a recession goes on for a long period or is a particularly bad recession then the recession is no longer considered a recession, but it is now an economic depression.

But the United States has its own way of judging recessions. In fact in the U.S. the judgment of the business-cycle dating committee of the National Bureau of Economic Research (NBER) regarding the exact dating of recessions is generally accepted by everyone. The reason for this is that the NBER actually has a more general framework for judging recessions compared to other groups. According to the NBER a recession is a significant decline in economic activity spread across the economy that lasts longer than just a few months.

The effect of the recession can normally be visible in real GDP, real income, employment, industrial production, and wholesale retail sales. They also tend to think that a recession begins after the economy reaches a peak of activity and ends as the economy reaches its trough. And between the trough and the peak the economy is actually in expansion, which is the normal state of the economy. But the best thing about recessions is that in most cases they are usually short lived and they have actually been rather rare in the past few decades.

Predictors of a recession

Many people often wonder if there is any way that you can predict a recession. The truth of the matter is that there is no exact way to predict a recession, but there are things that you can watch for to see if a possible recession is going to occur. Basically what this boils down to is that there are no predictors that are totally reliable in telling you whether or not a recession is going to happen, but there are some things that are regarded by many economists as possible predictors to a recession. Here is a list of some of the predictors that economists use to help determine if a recession is going to happen or not:

  • In numerous recession's stock market drops usually come before the beginning of the recession. But one thing that you need to keep in mind is that about half the drops of 10% or more since 1946 have not actually resulted in recessions. And on the other hand about half of the stock market decline came after the recessions already began.
  • Three month change in the unemployment rate and initial jobless claims.
  • Inverted yield curve uses yields on a 10 year and three month Treasury securities in addition to the Fed's overnight funds rate, this model was developed by Fed economist Jonathan Wright. But another model, which was developed by Federal Reserve Bank of New York economists, uses only the 10 year and three month spread. But neither of these are definite indicators because sometimes they are followed by a recession 6 to 18 months later, rather than happening before a recession.
  • Index of Leading Indicators, which is an American economic index that is used to estimate future economic activity. It is made up of 10 components that are used to help predict recessions. But keep in mind that the time lag between the signal of a recession and the actual recession has varied widely, not to mention the fact that on a few different occasions the index of leading indicators has fallen, but no recession has actually occurred. In fact this index has correctly predicted each of the 7 recessions during period of 1959-2001, but it also predicted 5 recessions that did not occur during this same period.

The ten components of the index are:

  • Average weekly hours worked by manufacturing workers
  • Average number of initial applications for unemployment insurance
  • Number of manufacturers' new orders for consumer goods and materials
  • Speed of delivery of new merchandise to vendors from suppliers
  • Amount of new orders for capital goods unrelated to defense
  • Amount of new building permits for residential buildings
  • The S and P 500 stock index
  • Inflation-adjusted monetary supply, M2
  • Spread between long and short interest rates, the yield curve
  • Consumer sentiment

History of recessions in the United States

If you pay attention to what the economists actually say you will discover the fact that since 1954 the United States has encountered 32 cycles of expansion and contractions. There has been an average of 17 months of contraction and 38 months of expansion during these cycles. But the good news is that they have actually been shorter and much less common in recent years. In fact since 1980 there have only been 4 recessions, which were:

  • January to July 1980, worst quarter GDP Growth -7.8%

  • July 1981 to November 1982, worst quarter GDP Growth -6.4%

  • July 1990 to March 1991, worst quarter GDP Growth -3.0%

  • March 2001 to November 2001, worst quarter GDP Growth -1.4%

Responding to a recession

There are numerous strategies that a country can use to respond to a recession, but what kind of strategies a country uses is going to depend on how that country's economy actually works and what they feel is best for their country. Here are some of the strategies that a country can use to respond to a recession:

  • Deficit spending by the government because it can spark economic growth, this is actually followed by Keynesian economists.

  • Tax cuts to promote business capital investments, this is actually practiced by other supply-sided economists.

  • Government remains "hands off" and does not interfere with the natural forces of the economy whatsoever; this is usually recommended and followed by laissez-faire economists.

  • Federal Reserve, in the United States, lowers the target Federal funds rate during recessions and other periods of lower growth. In fact this response has actually predated recent recessions. And because of the declining frequency of recessions in the past two decades and the reduction in declines in gross domestic product this actually suggests that the Federal Reserve has been successful in moderating contractions, basically in helping to prevent recessions.

Here are some examples of the rate cuts that the Federal Reserve has enacted during recessions and periods of low growth, these show the impact on short and long term interest rates:

  • July 13, 1990 to September 4, 1992: 8.00% to 3.00%, includes 1990 to 1991 recession
  • February 1, 1995 to November 17, 1998: 6.00% to 4.75%
  • May 16, 2000 to June 25, 2003: 6.50% to 1.00%, includes 2001 recession
  • June 29, 2006 to present: 5.25% to 2.25%

Global recessions

While there is no widely accepted definition of a global recession, economists all over believe that they do exist. In fact according to the economists at the International Monetary Fund or the IMF they feel that global recessions actually occur over a cycle lasting between 8 and 10 years. And during the last three global recessions, global per capita output growth was zero or negative.

The economists at the IMF also say that a global recession would take a slowdown in global growth to three percent or less. If you were to follow this measure there are actually three periods since 1985 that qualify for a global recession. Those periods are: 1990 to 1993, 1998, and 2001 to 2002.

The IMF has actually recently just lowered its 2008 global growth projection from 4.9% to 4.1%. And because of this and other factors there has been a lot of speculation about a possible recession in the United States. If the recession does happen it is actually expected to have a global impact, according to numerous economists. The reason why this United States recession is going to have a global impact is because the United States represents 21% of the global economy so the impact of a United States recession can spread through the following:

  • Dropping U.S. stock prices drag down markets elsewhere

  • The crisis of the United States subprime mortgage market has pushed up credit costs worldwide. It has also forced European and Asian banks to write down billions of dollars in holdings.

  • Less spending by the American consumers and American companies reduces the demand for imports, which in turn is going to have an impact on the countries that are making those products that the United States imports.

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