Yahoo Finance 'Failed': Redefining the meaning of recession
When it comes to assessing the health of an economy, the ‘two consecutive quarters of falling GDP’ is not a good definition for a recession. It ignores the performance of the economy over a longer time frame and overlooks what happens to the labour market and inflation in a downturn.
If there are two quarters of falling GDP, there is no doubt the economy is recession, but with more consideration of other economic fundamentals it should be obvious an economy can be in recession with a different trend for quarterly GDP.
I have been guilty, in the past, of using the ‘two quarters’ definition, but reflecting on recent business cycles, it is time for fresh thinking.
Consider an example where quarterly GDP has the following profile:
Quarter one: -1.0 per cent
Quarter two: +0.5 per cent
Quarter three: -1.5 per cent
Quarter four: +0.5 per cent
Under the ‘two consecutive quarters’ definition, the economy has not fallen into a recession.
But over the course of that year, GDP is a hefty 1.5 per cent lower. The economy that experienced this profile for GDP would inevitably be littered with failed businesses and a sharp rise in the unemployment rate, probably by around 1.5 percentage points.
This example would be a recession in its fairest and broadest measure.
More from The Kouk:
Others don’t have this hang-up about what is often labelled a ‘technical’ recession. In the US, they have a sensible approach to looking at what a recession is.
It is illustrative to note that the 2020 recession in the US lasted just two months. None of this ‘two consecutive quarters’ handwringing because the downturn was severe but very short-lived.
In the US, the National Bureau of Economic Research (NBER) has the kudos and credibility to define the whole domestic business cycle and as a result it judges when a recession starts and when it ends.
In making this assessment, the NBER noted: “In determining the date of a monthly peak or trough, the committee considers a number of indicators of employment and production”.
For the 2020, the NBER concluded that the recession lasted for two months, in March and April. The recession was deep and that the recovery started in May 2020 when employment and production started to increase after the sharp falls in the earlier months.
Indeed, the NBER places a high emphasis on employment in determining a recession and that should be the main focus of good economists.
These themes in judging the business cycle should be applied to Australia.
If employment and hours worked decline and the unemployment rate rises, the seeds have been sown for a recession in 2021.
If the economy is so weak, regardless of the quarter-by-quarter readings for GDP, that the unemployment rate rises by 1 percentage point or more within a relatively short time period, it is safe to say the economy is in recession. If output is also trending lower and inflation is decelerating, the benchmarks for a recession are confirmed.
Australia’s two recessions in two years?
There is no dispute that Australia registered a recession in 2020. GDP fell sharply, the unemployment rate rose by over 2 percentage points and inflation fell to a record low.
Today, as the lockdowns extend and intensify, Australia is getting close to recording another recession, even if it lasts for just three or four months.
In the current 2021 economic slump, the absence of additional economic stimulus will compound the lockdown downturn such is the fall out for economic growth and employment currently underway.
The labour force data over the next six months will reflect the slump in economic activity being experienced now.
Hard data on the economy on the extent and timing of the recession will be published over the next six months or so.
If, as seems likely, the unemployment spikes by 1 percentage point to around 6 per cent, and economic activity falls including for GDP which is widely expected to drop by 2.5 per cent, a recession can be declared.
Which begs an important question – what is the government and Reserve Bank of Australia (RBA) doing about it?
In 2020, monetary policy was eased and the government used fiscal policy to support the economy in the downturn and to spark a recovery. Both measures had a desirable impact with a solid recovery in late 2020 and early 2021.
So far in 2021, the RBA has signalled it will not add to monetary policy stimulus and the government is doing little to support growth and jobs. Indeed, with the winding back of bond buying, it is actually delivering a marginal tightening in monetary policy.
While the current recession is very unlikely to be as deep as in 2021, it will see many businesses and jobs lost. It will hurt.
Whatever the definition, recessions are never good as many can attest today.
Follow Yahoo Finance on Facebook, LinkedIn, Instagram and Twitter, and subscribe to the free Fully Briefed daily newsletter.
