Unpacking recession talk

The vulnerable state of the U.S. economy has been highly discussed for months, but both the vulnerability and the discussion took on a whole new dimension as the second quarter gross domestic product preliminary number came to light yesterday. Following an annualized contraction of 1.6 percent in the first quarter, the Q2 number also reflected economic contraction, this time at an annualized pace of minus-0.9 percent. The primary reason for a dimension of discussion is that two quarters of contraction in a row traditionally has been considered the technical definition of a recession.

Over the last few days, though, the White House went into a proactive damage control mode to assert otherwise. Brian Deese, the director of the National Economic Council, and Janet Yellen, treasury secretary and former chair of the Federal Reserve, loudly proclaimed that a recession involved deteriorating unemployment, and lacking that condition, this just can’t be called a recession.

Let’s first address the political reality. There is no doubt that if the shoes were on the other foot in terms of who held political power and the American economy experienced two quarters in a row of GDP contraction, the Democrats would gleefully declare this a recession. And in the interest of fairness, if the unemployment report was only 3.6 percent while GDP was contracting like this, Republicans likely would downplay the GDP report, as well. So the spin doctors in the press are no surprise, and, of course, the American people will do with it what they will.

But what is the economic reality here? Are we in a recession? How should we think about this entire affair?

First, the technical reality: We have no agreed-upon definition of a recession—not governmentally, not academically, and not linguistically. We do have a traditional understanding, and that understanding has essentially viewed two quarters of GDP contraction as a recession. But the bureau assigned with declaring a recession is an obscure government agency known as the National Bureau of Economic Research. It only provides this obscure language: “The NBER’s traditional definition of a recession is that it is a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”

We have a decline in economic activity, and it has lasted more than a few months (hence the “two quarters” criteria). The challenge in this discussion is that recessions have always included a decline in real wages and an increase in unemployment. Current conditions show very low unemployment and very high job openings.

So what gives? Some of this can be chalked up to the formula for how GDP is measured. Inventory reductions are the big cause in Q2, even as trade and consumer spending on services added to economic growth. Economists can debate about how the GDP measurement is weighted, but it has been weighted this way for a long time, meaning it reflects the aggregate measurement of factors we have always used.

My own belief has always been that business investment is the most significant factor in the real economy, because when it is advancing, regardless of what we may see in statistics related to inventory, trade, or the consumer, it very likely means productivity is happening. Business investment is a part of rational capital allocation, and it generally speaks to a confident and opportunistic economic environment, whereas its contraction speaks to fear or hesitation. I would argue that the real problem here is a lack of firm criteria and an inconsistent application of the criteria. This category was basically even in Q2, but its lack of positive growth meant it could not offset the inventory decline in the weighted numbers.

These two things are true at once: High current inflation levels and weak aggregate GDP growth are negatives in the economy, even as low unemployment and strong wages are positives (for now). Many Americans are convinced that those things will soon weaken as well, but that is a predictive statement, not a descriptive one. Economic challenges are certainly here, they are likely to worsen, but it is quite likely that this will prove to be a shallow recession.

But as for this present debate, the real problem is that we lack a concrete definition and have assigned the application of a subjective definition to an obscure government agency accountable to no one. Do we need a concrete definition? Perhaps the tradition of how we have viewed it is good enough (two quarters in a row). Perhaps we want to assign objective data levels to unemployment, industrial production, or some other economic metrics.

Or perhaps the American people are content to define a recession the way Justice Potter Stewart once defined something else quite crude and objectionable to most of us: “We know it when we see it!”