Recession

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In macroeconomics, a recession is generally associated with a decline in a country's real gross domestic product (GDP), or negative real economic growth, for two or more successive quarters of a year. However, this rule doesn't always hold true. The National Bureau of Economic Research's (NBER) Business Cycle Dating Committee ultimately decides whether the economy has fallen into a recession. The NBER does not use any specific methodology for determining the start and end dates of a recession - instead it looks at a variety of economic indicators over various time periods and determines whether to declare that the economy is in a recession based on those data.

In the US, the judgment of the business-cycle dating committee of the National Bureau of Economic Research regarding the exact dating of recessions is generally accepted. The NBER has a more general framework for judging recessions:

A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough.

A recession may involve simultaneous declines in coincident measures of overall economic activity such as employment, investment, and corporate profits. Recessions may be associated with falling prices (deflation), or, alternatively, sharply rising prices (inflation) in a process known as stagflation. A severe or long recession is referred to as an economic depression. Although the distinction between a recession and a depression is not clearly defined, it is often said that a decline in GDP of more than 10% constitutes a depression.^[1] A devastating breakdown of an economy (essentially, a severe depression, or a hyperinflation, depending on the circumstances) is called economic collapse.

Contents 1 Predictors of a recession 2 History of recessions in the United States 3 Responding to a recession 4 Federal Reserve response 5 Stock market and recessions 6 Global recessions 7 Possibility of a 2008 recession 8 Recession and politics 9 Causes of recessions 10 Effects of recessions 11 See also 12 Notes 13 References 14 External links

[edit] Predictors of a recession

There are no totally reliable predictors. These are regarded to be possible predictors.^[2]

• Stock market drops have preceded the beginning of recessions. However about half of the drops of 10% or more since 1946 have not resulted in recessions.^[3] Also, approximately half of the stock market decline came after the beginning of recessions.
• Inverted yield curve,^[4] the model developed by Fed economist Jonathan Wright, uses yields on 10-year and three-month Treasury securities as well as the Fed's overnight funds rate. Another model developed by Federal Reserve Bank of New York economists uses only the 10-year/three-month spread. It is, however, not a definite indicator;^[5] it is sometimes followed by a recession 6 to 18 months later.
• The three-month change in the unemployment rate and initial jobless claims.^[6]
• Index of Leading (Economic) Indicators (includes some of the above indicators).^[7]

Because of the way a recession is defined, the beginning (peak in the economic cycle) or end (trough) of a recession can only be identified after the change in the trend has been present for several months.

The 2001 recession was announced by the NBER in November 2001^[8], which later turned out to be the truth. Thus the recession ended the month it was announced by the NBER. In July 1981 the NBER declared an end to a six-month recession from January to July 1980, the last year of Jimmy Carter's presidency. For the 1981-82 recession, which was during President Reagan's first term, the NBER announced the July 1981 peak in January 1983, and the November 1982 trough in July 1983.^[9]

Economist Robert J. Gordon, a member of the NBER committee has stated that any announcement about the start of a new recession starting in 2008 is unlikely before the last few months of 2008 at the earliest^[10].

[edit] History of recessions in the United States

According to economists,^[11] since 1854, the U.S.A. has encountered 32 cycles of expansions and contractions, with an average of 17 months of contraction and 38 months of expansion. However, they have been shorter and much less common in recent years. Since 1980, there have been only seven recessions (see charts to see how stocks did in these periods). The charts show the impact on stock market indices.

• January-July 1980: 6 months chart (worst quarter GDP Growth -7.8% spreadsheet)
• July 1981-November 1982: 16 months chart (worst quarter GDP Growth -6.4%)

• July 1990-March 1991: 8 months chart (worst quarter GDP Growth -3.0%)
• March 2001-November 2001: 8 months chart (worst quarter GDP Growth -1.4%)

During March 1991 to March 2001, the U.S.A. experienced the longest economic expansion - 120 months.

For the past four recessions, the NBER decision has approximately confirmed with the definition involving two consecutive quarters of decline. However the 2001 recession did not involve two consecutive quarters of decline, it was preceded by two quarters of alternating decline and weak growth.

[edit] Responding to a recession

Strategies for moving an economy out of a recession vary depending on which economic school the policymakers follow. While Keynesian economists may advocate deficit spending by the government to spark economic growth, supply-side economists may suggest tax cuts to promote business capital investment. laissez-faire economists may simply recommend the government remain "hands off" and not interfere with natural market forces.

Both government and business have responses to recessions. In the Philadelphia Business Journal, Strategic Business adviser Carter Schelling has discussed precautions businesses take to prepare for looming recession, likening it to fire drill. First, he suggests that business owners gauge customers' ability to resist recession and redesign customer offerings accordingly. He goes on to suggest they use lean principles, replace unhappy workers with those more motivated, eager and highly competitive. Also over-communicate. "Companies," he says, "get better at what they do during bad times. He calls his program the "Recession Drill."[1]

[edit] Federal Reserve response

The Federal Reserve has responded to potential slow downs by lowering the target Federal funds rate during recessions and other periods of lower growth. In fact, the Federal Reserve's lowering has even predated recent recessions^[12]. The charts below show the impact on the S&P500 and short and long term interest rates.

• July 13, 1990-September 4, 1992: 8.00% to 3.00% (Includes 1990-1991 recession) rate drop chart rate rise chart
• February 1, 1995-November 17, 1998: 6.00 - 4.75 rate drop chart1 rate drop chart2 rate rise chart
• May 16, 2000-June 25, 2003: 6.50- 1.00 (Includes 2001 recession) rate drop chart1 rate drop chart2 rate rise chart
• June 29, 2006- (Mar. 18 2008): 5.25-2.25 rate drop chart

Siegel^[13] points out that cuts in the Federal funds rate are now widely anticipated; thus, cuts are no longer followed by a longer-term rise in stock market indexes.

The declining frequency of recessions in the past two decades and the reduction in declines in GDP suggest that the Federal Reserve has been successful in moderating contractions. However some critics argue that reducing the Federal funds rate has had the effect of adding too much liquidity to the financial markets.

[edit] Stock market and recessions

Some recessions have been anticipated by stock market declines. In Stocks for the Long Run, Siegel mentions that since 1948, ten recessions were preceded by a stock market decline, by a lead time of 0 to 13 months (average 5.7 months). It should be noted that ten stock market declines of greater than 10% in the DJIA were not followed by a recession^[14].

The real-estate market also usually weakens before a recession^[15]. However real-estate declines can last much longer than recessions.

Since the business cycle is very hard to predict, Siegel argues that it is not possible to take advantage of economic cycles for timing investments. Even the NBER takes a few months to determine if a peak or trough has occurred^[16].

During an economic decline, high yield stocks such as financial services, pharmaceuticals, and tobacco tend to hold up better^[17]. However when the economy starts to recover and the bottom of the market has passed (sometimes identified on charts as a MACD crossover), growth stocks tend to recover faster. There is significant disagreement about how health care and utilities tend to recover^[18]. Diversifying one's portfolio into international stocks may provide some safety; however, economies that are closely correlated with that of the U.S.A. may also be affected by a recession in the U.S.A.^[19].

[edit] Global recessions

There is no commonly accepted definition of a global recession.^[20] The IMF estimates that global recessions seem to occur over a cycle lasting between 8 and 10 years. During what the IMF terms the past three global recessions of the last three decades, global per capita output growth was zero or negative.

Economists at the International Monetary Fund say that a global recession would take a slowdown in global growth to three percent or less. By this measure, three periods since 1985 qualify: 1990-1993, 1998 and 2001-2002.^[21] International Monetary Fund has recently lowered its 2008 global growth projection from 4.9 percent to 4.1 percent (as measured in terms of purchasing power parity).^[22]

There is significant speculation about a possible U.S.A. recession in 2008. If it happens, it is expected to have a global impact.^[23][24][25] U.S. represents about 21 percent of the global economy. Impact of a U.S. recession can spread though the following:^[26]

• Less spending by American consumers and companies reduces demand for imports.
• The crisis of the U.S. subprime-mortgage market has pushed up credit costs worldwide and forced European and Asian banks to write down billions of dollars in holdings.
• Dropping U.S. stock prices drag down markets elsewhere.

[edit] Possibility of a 2008 recession

Further information: Economic crisis of 2008

Since 2007, there had been speculation of a possible recession starting in late 2007 or early 2008. The United States housing market correction (a consequence of United States housing bubble) and subprime mortgage crisis had significantly contributed to anticipation of a possible recession.

While some economists were confident about a recession^[27], others were not as easily convinced.^[28] While some believed that the current slowdown would at best be a mild and brief recession,^[29] there was always an anticipation that the economy may start recovering in the later part of 2008.^[30]

The 2008 performance of the U.S. economy is difficult to predict due to the declining house prices and the subprime crisis, the full impact of which is still unclear.

U.S. employers shed 63,000 jobs in February 2008, the most in five years, supporting the view that the U.S. is falling into a recession. ^[31]. NBER's president, Harvard University economist Martin Feldstein, recently said on March 14, 2008 we are in a recession, though it was not an official NBER declaration^[32]. He said the nation has entered a recession that could be the worst since World War II. The economists surveyed by Bloomberg News this month predicted the GDP growth will slow to 0.1 percent in January to March.

A TrimTabs report on April 1, 2008 suggested a possible ending of recession based on treasury withholding data in very near future^[33].

Martin Feldstein, head of NBER said on March 7, 2007: I think that December/January was the peak and that we have been sliding into recession ever since then. I think it could go on longer last two recessions (which) lasted eight months peak to trough".^[34]. However former Federal Reserve chairman Alan Greenspan said on April 6, 2008 that "There is more than a 50 percent chance the United States could go into recession." However Anatole Kaletsky has argued that recession unlikely if US economy gets through next two crucial months^[35].

On April 29, 2008, several US states are declared by Moody’s to be in a recession, they are as follows: Rhode Island, Ohio, Michigan, Wisconsin, Florida, Tennessee, California, Nevada and Arizona. ^[36]

The US Economy grew in the first quarter by 0.6%, meaning that the US does not meet the classical definition of a recession and the Commerce Department says the US is "stuck in a rut". However a number of economists still believe the economy is in a recession.^[37][38]

[edit] Recession and politics

Generally an administration gets credit or blame for the state of economy during its time.^[39] This has caused disagreements about when a recession actually started.^[40] In an economic cycle, a downturn can be considered a consequence of an expansion reaching an unsustainable state, and is corrected by a brief decline. Thus it is not easy to isolate the causes of specific phases of the cycle.

The 1981 recession is thought to have been caused by the tight-money policy adopted by Paul Volcker, chairman of the Federal Reserve Board, before Ronald Reagan took office. Reagan supported that policy. Economist Walter Heller, chairman of the Council of Economic Advisers in the 1960s, said that "I call it a Reagan-Volcker-Carter recession.^[41] The resulting taming of inflation, did, however, set the stage for a robust growth period during Reagan's administration.

[edit] Causes of recessions

• Speculation
• Futures contracts
• National debt
• Inflation
• Devalued currency

[edit] Effects of recessions

• Unemployment
• Foreclosures
• Bankruptcies
• Stock market downturn
• Reduced sales
• Banks lend less money
• Inflation

[edit] See also

• List of recessions in the United States - A list of important recessions in the United States
• Great Depression - August 1929 to March 1933: longest recession of the 20th century
• Age wave theory - Consequence of baby boomers retiring
• Oil crisis - Global oil crises
• Remission, the equivalent in medicine

[edit] Notes

• The Thirty-Five Most Tumultuous Years in Monetary History: Shocks and Financial Trauma, by Robert Aliber. Presented at the IMF
• Encyclopedia Britannica, Depression
• Recession? Depression? What's the difference? (About.com)

[edit] References

[edit] External links

• Business Cycle Expansions and Contractions, the National Bureau Of Economic Research
• Independent Analysis of Business Cycle Conditions - American Institute for Economic Research (AIER)
• Recession Library - US Economic Recession History News and Videos