Paul Krugman: Recession is a matter of definition

The Bureau of Economic Analysis, which produces the numbers on gross domestic product and other macroeconomic data, declared on Thursday that real US gross domestic product shrank in the second quarter of 2022.

Since it has already announced that real GDP shrank in the first quarter, there is a lot of breathless commentary to the effect that we’re officially in a recession.

But we won’t be. That’s not how recessions are defined; more important, it’s not how they should be defined. It’s possible that the people who actually decide whether we’re in a recession – more about them in a minute – will eventually declare that a recession began in the United States in the first half of this year, although that’s unlikely given other economic data. But they won’t base their decision solely on whether we’ve had two successive quarters of falling real GDP.

To understand why, it helps to know a bit about the history of what is known as business cycle dating.

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A modern economy is a constantly changing thing, in which individual industries rise and fall all the time. (Remember video rental stores?) At some point in the 19th century, however, it became obvious that there were periods when almost all industries were declining at the same time – recessions – and other periods during which most industries were expanding.

To understand these fluctuations, economists wanted to compare different recessions and search for common features. But to do that, they needed a chronology of recessions, one based on a variety of measures, since GDP didn’t even exist yet as a concept, let alone a number regularly estimated by the government.

Business cycles

A seminal 1913 book by American economist Wesley Clair Mitchell is widely credited with beginning the systematic empirical study of business cycles.

In 1920, Mitchell helped found the National Bureau of Economic Research, an independent organisation that soon found itself devoting much of its research to economic fluctuations and began offering a chronology of business cycles in 1929.

Since 1978, the bureau has had a standing group of experts called the Business Cycle Dating Committee, which decides – with a lag – when a recession began and ended based on multiple criteria, including employment, industrial production and so on. And the US government accepts those rulings.

So the official definition of a recession is that it is a period that the committee has declared a recession; it’s an expert judgment call, not a formula.

So where did the two-quarter thing come from? Part of the answer is that the bureau doesn’t make recession calls in real time. For example, while the Great Recession is now considered to have begun in December 2007, the dating committee didn’t make that call until December 2008.

Also, other nations don’t have any equivalent of the bureau. So there has always been an incentive to look for simple formulas, not dependent on judgment, that can quickly determine a recession.

Two quarters of economic contraction – a downturn sustained enough that it probably isn’t a statistical blip – seems, on the surface, like a reasonable criterion.

But it’s not hard to see how it could be deeply misleading, even if the data is correct. Imagine, for example, an economy that suffered a severe slump for one quarter, then briefly stabilised and grew a bit, then resumed its plunge for another quarter. Would you really want to deny that this economy experienced a recession?

Sahm Rule

There are better indicators. The Sahm Rule, developed by Claudia Sahm, a former Fed economist currently at the Jain Family Institute, tries to identify the start of recessions by looking for significant increases in the unemployment rate.

In fact, if we didn’t have the bureau to make the determination, there would be a good case for viewing the Sahm Rule not as a predictor but as a definition: a recession has begun when the Sahm Rule says it has. And right now the rule emphatically does not say that we’re in a recession.

That’s partly because the GDP numbers seem out of sync with many other economic indicators – part of a general picture in which economic data seems to be telling inconsistent stories. (Perhaps because, to use a technical term, we’re still somewhat discombobulated by the pandemic.)

Employment growth, for example, has been solid. Is that consistent with a recession? Even gross domestic income – a number that in principle should be literally equal to GDP but is estimated using different data – isn’t telling the same story, because it didn’t decline in the first quarter.

So it was somewhat foolish to declare that we’re in a recession. And what difference would a recession call make, anyway? What should matter is the state of the economy – which is complicated – not the particular word we use to describe it.

Unfortunately, the American political scene being what it is, we’re probably about to see a firestorm of demands that the National Bureau of Economic Research committee immediately declare a recession and that the Biden administration admit that one is in progress; I’m already hearing rumblings that the administration will be applying a double standard if it refuses to accept the “official” rule that two quarters of negative growth define a recession.

Well, there is no such rule. It’s quite possible that we will in fact experience a recession soon; it’s even possible, although less likely, that one has already started. But there’s no reason to use the R-word this week.

This article originally appeared in The New York Times