Economic cycle: Expansions and Recessions; what is the depression?

Autor: Bancherul.ro
2011-05-02 13:46

Is really “two down quarters GDP” the most appropriate way to measure one recession? The question was risen in an article published in Macro Report Private Banking edited by OTP Bank Romania.

In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way. GDP, employment, investment spending, capacity utilization, household incomes, business profits and inflation all fall during recessions; while bankruptcies and the unemployment rate rise.

Recessions generally occur when there is a widespread drop in spending often following an adverse supply shock or the bursting of an economic bubble. Governments usually respond to recessions by adopting expansionary macroeconomic policies, such as increasing money supply, increasing government spending and decreasing taxation.

In a 1975 New York Times article, economic statistician Julius Shiskin suggested several rules of thumb for defining a recession, one of which was two down quarters of GDP. In time, the other rules of thumb were forgotten. Some economists prefer a definition of a 1.5% rise in unemployment within 12 months.

Starting with 1979, in the United States, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) is generally seen as the authority for dating US recessions.

The NBER does not rely on the “two down quarters of GDP” rule and defines an economic recession as: "a significant decline in economic activity spread across the country, lasting more than a few months, normally visible in real GDP growth, real personal income, employment (non-farm payrolls), industrial production, and wholesale-retail sales." Almost universally, academics, economists, policy makers, and businesses defer to the determination by the NBER for the precise dating of a recession's onset and end.

NBER identify a month when the economy reached a peak of activity and a later month when the economy reached a trough. The time in between is a recession, a period when economic activity is contracting. The following period is an expansion.

The Committee does not have a fixed definition of economic activity. It examines and compares the behavior of various measures of broad activity: real GDP measured on the product and income sides, economy-wide employment, and real income. The Committee also may consider indicators that do not cover the entire economy, such as real sales and the Federal Reserve's index of industrial production (IP).

The committee does not make real-time judgments, there are no timing rules, it waits for the availability of all relevant data and for the completion of early data revisions. The committee then looks back on history and determines in what month the economy reached bottom and began to expand again. The committee also has to guard against the possibility, even if very small, that what seems to be the beginning of an expansion is actually just an interruption in a longer contraction. The committee waits long enough so that the existence of a peak or trough is not in doubt, and until it can assign an accurate peak or trough date.

Recession impacts

The full impact of a recession on employment may not be felt for several quarters. Research shows that low-skilled, low-educated workers and the young are most vulnerable to unemployment in a downturn.

Productivity tends to fall in the early stages of a recession, and then rises again as weaker firms close. The variation in profitability between firms rises sharply. Recessions have also provided opportunities for anti-competitive mergers, with a negative impact on the wider economy: the suspension of competition policy in the United States in the 1930s may have extended the Great Depression.

The living standards of people dependent on wages and salaries are more affected by recessions than those who rely on fixed incomes or welfare benefits. The loss of a job is known to have a negative impact on the stability of families, and individuals' health and well-being. Economists usually teach that to some degree recession is unavoidable, and its causes are not well understood. Consequently, modern government administrations attempt to take steps, also not agreed upon, to soften a recession.

Depression vs. Recession

The NBER does not separately identify depressions. The NBER business cycle chronology identifies the dates of peaks and troughs in economic activity.

The term depression is often used to refer to a particularly severe period of economic weakness. Some economists use it to refer only to the portion of these periods when economic activity is declining. The more common use, however, also encompasses the time until economic activity has returned to close to normal levels. The most recent episode in the United States that is generally regarded as a depression occurred in the 1930s. The NBER determined that a peak in economic activity occurred in August 1929, and that a trough occurred in March 1933. The NBER identified a second peak in May 1937 and a trough in June 1938. Both the contraction starting in 1929 and that starting in 1937 were very severe; the one starting in 1929 is widely acknowledged to have been the worst in US history. According to the Bureau of Economic Analysis, real GDP declined 27% between 1929 and 1933, roughly five times as much as in the worst postwar recession. If the term Great Depression is used to mean the period of exceptional decline in economic activity, it refers to the period from August 1929 to March 1933. If it is used to also include the period until economic activity had returned to approximately normal levels, most economists would judge that it ended sometime in 1940 or 1941. However, just as the NBER does not define the term depression or identify depressions, there is no formal NBER definition or dating of the Great Depression.

1 The NBER was founded in 1920, and published its first business cycle dates in 1929. The committee was created by the President of the NBER in 1978. Robert Hall has chaired the committee since its inception. The President of the NBER appoints the members, who include directors of the macro-related programs of the NBER plus other members with specialties in business-cycle research. During the period 1961-1978, the U.S. Department of Commerce embraced the NBER turning points as the official record of U.S. business cycle activity, but the NBER made no formal announcements when it determined the dates of turning points. There was an informal notification between the NBER members and the Commerce Department, followed by publication in the Commerce Department publication.

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