December 21, 2000
The "r" word--recession--has surfaced with a vengeance in recent days. The advisors to President elect Bush are using that word to describe the current economic state of affairs, while President Clinton is waving the forecasts of the Blue Chip economists to indicate that economic growth will be more than 2.5 percent next year, which is not a recession.
Of course, the recession charges are about politics, not economics (and this is a more conciliatory Washington). Bush wants any economic slowdown to be charged to Clinton. If a recession looms, its effects will still be lingering during the 2002 congressional elections. Bush does not want to see Republicans lose because of Clinton policies.
Before going further, I should mention that the Blue Chip economist forecasts are good, except during recessions. In 1990, the forecast was off by 2.5 percentage points. Therefore, Clinton's claim that the leading forecasters do not see a recession coming, merely means that those forecasters cannot see recessions too well.
Although popular beliefs are that a recession is two consecutive quarters of negative economic growth, that is not correct. The recession of 1970 had two quarters of decline but they were separated by two quarters of growth. In 1980, the recession had only one negative quarter, but it was a major plunge. Indeed, business cycle economists continue to debate whether either of those two events should have qualified as a recession.
According to the National Bureau of Economic Research, those recessions stand. The National Bureau has a dating committee that examines whether economic weakness is sufficient to qualify as a recession. In other words, a vote by a committee of economists determines whether a recession has occurred. Furthermore, this vote usually is taken well after the decline has commenced.
Although the committee can use whatever information they can muster, they tend to be guided by the three D's--depth, duration, and dispersion. A mildly declining economy that continues to fall will be classified as a recession, even when the cumulative weakness is small. A plunging economy, even if the weakness does not last long, such as in 1920 or in 1980, normally is called a recession. Most importantly, if weakness is widespread, touching many sectors of the economy, then the condition is called a recession.
In that light, the current condition does not yet qualify as a recession. Only 46 percent of manufacturing firms are reporting employment gains, but 53 percent of all industries still are hiring more than they are firing. Industrial production has declined for two consecutive months, but most of the weakness has been in autos. Unemployment claims are rising, but employment continues to expand.
On the other hand (where is that one armed economist), what I call the internal dynamics of this economy are deteriorating. Business sales fell by 0.2 percent in October, while inventories grew 0.6 percent. A similar imbalance between inventories and sales appears to have occurred in November as goods remained on the shelves. Production has begun to fall in many industries during December, but a reluctant consumer appears to have allowed goods to stay on shelves.
The workweek is declining, suggesting that jobs may actually need to be cut to restore balance between production and employment. Consumers have been spending more than they are earning and are now experiencing a decline in the value of their equity holdings. This normally means a rise in desired savings is about to commence. Indeed, the sluggish Christmas sales might suggest that such a shift in consumer desires already has developed.
Moreover, almost all the leading indicators that matter are showing declines. The GSU indicators for the Southeast have now been declining for four months. The national leading indicators have not increased this year and have fallen for four consecutive months. Significantly, the coincident indicators fell in October, the last month currently available.
In short, the risk of recession is rising. Indeed, if these trends are not reversed soon, we may already have begun a recession in October (the first month of declining coincident indicators). But there still is enough time to prevent the economy from declining sufficiently or for a long enough period to qualify as a recession.
Indeed, the good news is that short term interest rates adjusted for core inflation probably can be cut by a full percentage point without raising the risk of inflation. Government surpluses permit tax reductions and/or spending increases of well over $150 billion per year without pushing up long term interest rates. In fact, the recent plunge in long term rates suggests that some reduction in that surplus is desirable at this time.
In other words, economic conditions are deteriorating, but we have sufficient dry powder in our policy area to prevent serious economic damage. All we need now is the will to begin changing that policy.