July 30 , 2003

Finally, the National Bureau of Economic Research has decided that the past recession was one of the shortest and mildest on record.  For those still losing their jobs, the November 2001 ending to the recession seems as ludicrous as declaring that peace exists in Iraq. 

All of which raises the question of whether this business cycle dating process makes sense anymore. 

The economy has changed dramatically since Wesley Mitchell and Arthur Burns concluded that economic cycles had consistent characteristics that would allow economists to determine when an expansion was in jeopardy and when a rebound was beginning.  They correctly noted that orders and building permits changed before employment and production. 

Households and companies tended to accumulate liquid assets before they made purchases.  When companies thought credit was getting easier, they borrowed short term.  When it was tightening, they tried to borrow long term. 

By establishing a series of indicators that captured this behavior, Mitchell and Burns believed that a barometer predicting economic changes would be as effective as the weather barometer predicting weather changes.  This is how the whole process of business cycle dating came about. 

However, in those times, production and manufacturing were dominant.  The hourly workweek changed before workers were hired or fired.  Inventories changed before production lines were opened or closed.  There was a pace of business that readily was reflected in the economic statistics. 

That pace of business still exists for goods producing industries.  However, most economic activity today is service oriented.  Indeed, we are even changing who qualifies for overtime hours.  Just think how much less useful that workweek measure is becoming. 

Now, I do believe that new indicators may surface to capture the mood changes by businesses and consumers that precedes their changes in spending patterns.  Adding consumer expectations and the interest rate spread between short and long term rates tries to capture some of that shifting process.  Nevertheless, the current indicators simply are not as close to prevailing economic conditions as the old indicators were, and they probably never will be again. 

So, are we wrong to date the timing of downturns anymore.  Just as we may suffer more casualties in Iraq after the large fighting is over, we are suffering large job loss after the recession is over.  Just as Iraq is not yet peace, this is not yet recovery. 

Perhaps we need another word to name this process. 

Nevertheless, some useful information comes from the dating of the recession.  For instance, construction spending begins falling quickly when a recession begins.  It then slows its rate of decline but continues to drift lower until after employment growth returns.  Normally, this process takes about two years to thirty months. 

We are approaching thirty months from the beginning of the downturn, and private construction appears to be following this normal cyclical pattern. 

Other patterns that are following normal cyclical behavior are productivity changes, reduced inflationary pressures, interest rates (they normally fall for a full year after the recession is declared over.  This time, it looks like the decline is about one and a half years, close enough for government work). 

Aside from employment changes, abnormal behavior is seen is corporate profits, stock prices, and state and local revenues.  Profits fell on queue, but they plunged by 21 percent while the recession was mild.  In other words, profits took the brunt of the economic weakness, just as they took most of the gains of the previous expansion. 

Stock prices lagged the downturn by a month and seriously lagged the upturn.  As a rule, stock prices are a leading indicator, but they were very slow this time.  When they decided to move upward, however, they moved up much more strongly than earnings.  Normally, the ratio of stock prices to earnings stalls after an initial surge and remains below normal relative to historical experience until the expansion reaches above normal rates of growth. 

This time, stock prices jumped much more quickly than earnings, although they waited until earnings actually began to rise and continue to grow much faster than earnings are growing. 

Perhaps the shift to a service based economy has created a new business cycle that requires an entirely new interpretation.  Alternatively, the old cyclical forces may still be at work, but we are being pummeled by more external shocks than normal cycles endure.  We will need more information to know what explanation is more relevant for today's economy. 

In the meantime, those looking for a job should know that rising long term interest rates when short term rates are below normal and a rising stock market remain signals of improved activity ahead.  If no more external shocks arrive, their job search persistence should begin paying off. 


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