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The Ghosts of Recession Past, Present, and Future

We all know Charles Dicken’s “A Christmas Carol.” Ah, yes, the tale of an abusive capitalist duck, a hard working mouse, and therapy by haunting. Or, were the Muppets involved? In any case, that Christmas classic got me thinking about the possibility of economic recession. Wait…what?

You see, I was hosting an end-of-semester lunch for some of my first-year students. And while I thought the conversation would hinge on grades and our upcoming exam, instead the students came prepared with awesome questions about our nation’s economy. Many of their questions centered on one topic: recession. (You know that you teach a dismal subject when even a celebratory lunch turns into a discussion of looming economic catastrophe…bah humbug!)

My students had all sorts of questions about recession. They had questions about recessions past: did we already have one? They had questions about recessions present: were we in a recession right now? And, they had questions about recessions future: was a recession coming down the pike? Since they were so interested, I thought you might be too. So, let’s take these questions just like those old ghosts visit Mr. Scrooge McDuck — past, present, and future.

(P.S. If you liked this marginally clever intro, don’t forget that I have a book you can buy with oh so much more fun!)

Ghost of Recession Past: Did We Already Have One?

First things first. What is a recession? People in the popular discourse often define a recession as two consecutive quarters of negative real Gross Domestic Product (GDP) growth. But, this definition is not recognized by either the government nor by economists. Instead, they rely on the National Bureau of Economic Research’s (NBER) Business Cycle Dating Committee. That committee defines a recession as: “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” In general, this decline would show itself both in measures of economic output, like GDP, and also of employment, like the unemployment rate.

So, have we had such a decline recently? It depends on what you consider “recently.” According to the NBER, the last recession experienced by the U.S. was from February 2020 to April 2020, during the initial stages of the COVID Pandemic. At just two months, that recession was the shortest ever on record.

However, we have not had a recession since April 2020, despite the fact that inflation (or politics!) has caused many to view the economy negatively. The NBER’s view of no new recession is not entirely without controversy. To see why the controversy — and also why NBER does not believe a recession has occurred — Figure 1 shows the Real GDP growth rate and the unemployment rate for each quarter since Q4 2020.

Figure 1. Real GDP Growth from Prior Quarter (Red Bars) and Unemployment Rate (Grey Bars)

Source: U.S. Bureau of Economic Analysis (GDP) and U.S. Bureau of Labor Statistics (Unemployment), accessed through Federal Reserve Economic Data.

You can see from the red bars that we did have two consecutive periods of negative GDP growth in Q1 and Q2 2022. Yet, the NBER did not declare a recession. Why not? Among other reasons, because the grey bars show that unemployment continued to fall throughout this period. So, although one measure of economic activity showed decline, another showed strength. Apparently, the NBER felt that the continued strength in employment outweighed the decline in GDP. So, officially, no recession in the very recent past. What about right now?

Ghost of Recession Present: Are We In One?

The NBER declares recessions retroactively — for example, NBER announced the start of the 2020 recession in June 2020…after the recession was technically already over! (The fact that the COVID Recession ended in April 2020 wasn’t even announced until July 2021. Economists are nothing if not deliberate!) So, it’s possible that we are in a recession right now, and we find out later. So, are we?

Probably not. Most major forecasters anticipate GDP growth in the fourth quarter of 2022 was solidly positive. So, the main measure of economic output is likely not declining as I type.

And, other measures that would likely be flashing red if we were actively in a recession don’t seem to be. For example, one metric that I always keep my eye on is initial unemployment claims. This measure captures how many new people filed for unemployment benefits in the past several weeks, and will start to rise even before the unemployment rate itself does. Yet, the number of initial claims has been flat for a year, and the most recent measure even fell. Other measures that would likely be declining if we were already in a recession include consumers’ disposable income and their subsequent spending. After all, a recession is usually accompanied by layoffs or hours reductions, limiting workers’ paychecks. Yet, those numbers also increased in their most recent readings.

And while layoffs in the tech sector have garnered headlines, a key part of the recession definition is that it be “spread across the economy.” As the most recent unemployment report made clear, many sectors such as healthcare, construction, and hospitality are still growing. Indeed, the overall unemployment rate fell in December 2022.

So, if you ask me, we probably aren’t in a recession presently.

Ghost of Recession Future: Is One Coming?

On this question, I will put on my economist hat and say, “it depends.” So, let’s play a game of bad cop/good cop. Bad cop is going to kick over your chair, knock over your coffee, and tell you a recession is coming. Good cop will pick up the chair, give you a new cup of coffee, and tell you that we are in good shape.

Bad Cop: We are in Trouble!

A variety of indicators and professional forecasters believe that a recession is on the way. I’ll start with the indicator that has people the most worried — the dreaded negative 10-Year versus 3-Month Treasury Spread. In general, investors require higher interest payments to hold longer-term debt like a 10-Year Treasury Note versus a 3-Month Treasury Bill. After all, more can go wrong over a longer period of time, i.e., there is more risk. So, when you subtract the interest rate on a 10-year Government Security from a 3-Month one, you usually get a positive number.

However, when near-term economic prospects dim, investors may move away from short-term securities and towards longer-term ones. When this occurs, investors are willing to accept lower interest rates on those longer term securities than short-term ones. So, you may actually get lower interest rates on long-term debt. Often times, this “negative spread” occurs right before a recession. The picture below — courtesy of the Federal Reserve — shows that a negative spread often proceeds a grey shaded area, which indicates a recession. The 1991, 2001, 2008, and 2020 recessions were all proceeded by a negative spread. And, right now, it’s negative.

Figure 2. 10 Versus 3-Month Treasury Rate Spread

Other so-called “leading economic indicators” are not looking great either. For example, building permits for new private housing have showed a steep decline, boding ill for the construction industry. And, consumer sentiment is at an all-time low according to the long-running University of Michigan Index of Consumer Sentiment. Consumers who expect bad things may start saving and stop buying, triggering a recession. All of this has led trusted forecasters, like The Conference Board, to signal a warning for recession.

Ok, so all of that sounds bad. But, I think there is reason for hope.

Good Cop: It will be OK!

In my mind, the good cop argument comes down to a race between inflation and the labor market. Can inflation be lowered to its usual level through Fed-imposed high interest rates before high borrowing costs lead businesses to start cutting jobs? In the past, the answer has been no. But, this time around, the labor market has an ace in the hole — a tremendous number of job openings. Figure 3 plots the annual inflation rate versus the number of job openings and you can see that right now the race is on.

Figure 3. Number of Job Openings (Left Axis) Versus Inflation Rate (Right Axis)

Source: U.S. Bureau of Labor Statistics accessed through Federal Reserve Economic Data.

You can see that inflation seems to have peaked at about 9 percent annually, but has been falling for several months. And, at roughly the same time, job openings seem to have peaked at about 12 million, but have also been falling. The question: could we get away with only destroying job openings, but not jobs held by people? Right now, a 3 million job opening gap exists between where we are right now and where we were prior to the COVID-19 Pandemic. So, in theory, any looming economic downturn could destroy 3 million job openings without costing anyone their actual job.

This cushion of job openings is probably why the labor market keeps humming along. Employers are taking down job ads, not firing their current employees. Can this go on long enough to get inflation under control? Only time will tell. But, for my money, I hope the Good Cop is right. Because the people hurt by recession are often the least able to bear it.

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