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Recession or Not? Part I by Sven R. Larson

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Recession or Not? Part I

Back in July, when the U.S. Bureau of Economic Analysis, BEA, released its second-quarter numbers for gross domestic product, GDP, many pundits declared that the American economy was in a recession. This sentiment has persisted, even after the BEA updated its numbers. For example, the Washington Examiner proclaimed:

GDP fell at a 0.6% annualized date in the second quarter, a revised estimate from the Bureau of Economic Analysis showed Thursday morning, 0.3 percentage points better than initially estimated. The updated report confirmed the second straight quarter of declining inflation-adjusted GDP—a situation commonly used to define a recession. GDP tumbled at a 1.6% rate in the first quarter. 

But how can the U.S. economy be in a recession when unemployment is only 3.8%? After all, this is close to where it was during the excellent Trump economy. Even better: we have to go back to 1969 to find an unemployment rate for the month of July that can match the number for July of 2022.

Despite the very low unemployment rate, predictions of a recession still echo through the media. Similar sentiments can be heard in Europe. Therefore, in a two-part series starting now, I will examine the American and the European economies in search of an answer to the big “R” question.

***

But wait—is there even a doubt about the recession? Did we not just listen to a quote from the Washington Examiner explaining that two consecutive quarters of declining GDP by definition puts us in a recession?

Yes, that’s what the quote said, and they were not alone. Unfortunately, all the economists and analysts who made the recession call were wrong. 

While it is correct that a recession is defined by two consecutive quarters of declining GDP, it is not correct that the American GDP declined two quarters in a row. The number used to reach that conclusion is a GDP number that has been through so much statistical manipulation that it really does not tell us anything about the real world. 

Here is how it works. The statistics agency that produces the GDP numbers, in this case, the BEA, produces a raw-data GDP number—in other words, an unfiltered image of what is going on out in the economy. It is useful for a number of purposes, but it has its limitations. The most obvious one is that it cannot tell us anything about economic growth: if this raw-data GDP grows by, say, 5% in a year, we don’t know if that was because prices increased or people bought 5% more goods and services. 

To solve this problem, economists developed statistical methods for separating prices from quantities. The result is the inflation-adjusted GDP number, which we use to measure economic growth. As a nice spin-off, we also get the GDP deflator, the most comprehensive measurement of inflation available. 

The BEA publishes this inflation-adjusted GDP data in its national accounts table 8.1.6. Based on its numbers, we check for a recession by calculating how GDP has changed from one quarter to the next, specifically from Q4 of 2021 to Q1 of this year, and on to Q2. 

We do indeed get a negative number for Q1, in the form of a 4.7% decline from Q4 last year. However, in Q2 the economy expanded by 2.5%.

Clearly, these are not the numbers that the recession pundits rely on. They turn to numbers that have gone through two more steps of statistical manipulation: first, they adjust for so-called seasons and primarily holidays. If, for example, Christmas falls on a weekday instead of a weekend, there are fewer work days than December. As a result, less economic activity takes place. 

The seasonal adjustment method re-calculates GDP for that month as if the number of holidays was the same as December the year before. 

The next manipulation is the so-called annualization. Simply put, this is done in one of two ways. We can add up the total GDP for four consecutive quarters and roll that addition forward over time. Alternatively, we can take GDP for one quarter, multiply it by four and pretend that it represents an entire year’s worth of GDP.

This last method is downright stupid. It adds no analytical value and only confuses people who want to understand economic data. 

The recession pundits rely on the first annualization method. Their numbers, which are also adjusted for inflation and seasons, can be found on the BEA website as national accounts table 1.1.6. Here, we find that the American economy contracted by 1.6% in the first quarter of this year, and 0.6% in the second quarter. 

Unfortunately, these numbers are pointless. Why would you use a whole year’s worth of GDP to measure the growth rate from one quarter to the next? This is like asking your kid how much more money he spent today compared to yesterday, asking him to sum up how much he spent over the past seven days. 

The fact that the numbers are seasonally adjusted does not help either. 

As mentioned, using GDP data from the aforementioned BEA table 8.1.6, we find that the U.S. economy is not in a recession. 

But are there actually signs of an economic downturn? 

Yes, but you have to look deep to find them, and they are far from conclusive. First, though, let us take a closer look at the labor market, where unemployment is 3.8%.

The best way to get an overview of the labor market is to look at the employment rate. It comes in two forms, LF and LN. The LF rate is a mirror image of the unemployment rate, while the LN version compares the number of employed persons to the entire population within the same age segment.

In July, the LF rate for the U.S. economy was at 96.2%, mirroring the 3.8% unemployment rate. This is one of the ten best monthly LF rates in at least 20 years, and fully in line with what we saw in the strong Trump economy. 

When we turn to the LN rate, things still look good but not as spectacular. In July, 60.2% of the U.S. population aged 16 or more was employed. This is the highest ratio since February 2020; in 2017-2019, the LN rate averaged 60.4%. The last time before that, with LN above 60%, was in 2008.

In other words, there are no recession signals in the employment rate. A more detailed look, including hours worked and weekly pay, comes to the same conclusion: 

  • Total hours worked fell by an entirely normal 0.3% from June to July; the months of May and June were also average;
  • Hourly earnings increased by 0.8% from June to July, one of the better numbers for a summer month over the past ten years.

Private consumption is another good source of downturn indicators: if consumers spend less, or change their spending patterns from more confident purchases to more cautionary outlays, we can assume that they are worried about getting laid off or otherwise losing income. This would be a classic indicator of a looming recession.

Adjusted for inflation, consumer spending in July was 2.2% higher than in the same month in 2021. This number is almost exactly the same as the average real growth in private consumption from 2002 through 2019. 

Still no recession signs. 

However, buried deep in consumption data we find a couple of early-warning numbers. Starting with the weakest of them, spending on traditional, long-term items such as motor vehicles and durable housing equipment (think furniture and appliances) has declined in 2022:

  • So far this year, purchases of new motor vehicles have declined by an inflation-adjusted 8% year to year, though they ticked up by 3.3% in July; light trucks, a fuel-thirsty American favorite, were actually up by 4.9%;
  • Furniture purchases are down by 5.8% so far this year, though by only -1.2% for June;
  • Household appliance purchases have fallen 5% so far; again, July is an exception with a 2% increase.

The July numbers are most likely an aberration from a trend of weaker spending on consumer durables. That said, purchases of home entertainment and information processing equipment are up considerably in July, after having increased earlier in the year:

  • 21% more television sets; 
  • 12% more computers;
  • 11% more software;
  • 11% more telephones.

Even more interesting is the 9.5% rise in purchases of jewelry and watches in July (almost 12% year-to-year thus far for 2022). Together with the spending on consumer electronics, this indicates a shift from items that build your life—homes and vehicles—to items that have entertainment value or store value through hard times.

A more significant indicator of possible hard times ahead is the decline in spending on food and beverages. It stands at -2.6% after inflation so far in 2022, with the July number being -4%. Spending is down in almost every category, with the exception of alcoholic beverages and wine in particular (up 2.2%). 

So much for consumers buying goods of all kinds. In terms of services, which account for about two-thirds of consumer spending, there are virtually no recession signs to be found. Recreational services, such as “going to the movies” or attending live music events, have returned to normal after the pandemic. The same goes for dining at restaurants, staying at hotels, and getting haircuts. 

The small signs we see of pessimism among consumers are more likely to be related to inflation than fears of losing one’s job. When consumers expect persistently high inflation, they tend to reduce their spending and free up as much cash as possible. This allows them to accommodate a higher cost of living. We have not yet seen this on a consistent level, but the discretionary changes in spending on goods could be a first sign of such a shift.

As for inflation, there is a greater likelihood that it will decline than increase in the near future; in recent months, consumer-price inflation has plateaued. This followed 18 months of rising inflation: 

  • In November 2020 inflation stood at 1.2%; 
  • In June this year, it topped out at 9.1%. 

Then in July, the rate dropped to 8.5%. 

This minor drop is explainable in part by the trend in producer prices: in 2021, the so-called PPI, Producer Price Index, climbed rapidly from 2.8% in January to 20.1% in June. It remained roughly at that level for a whole year. Then in July, it dropped to 17.2%. 

This drop has not yet worked its way into the consumer prices—statistically, there is a two-month lag from PPI to CPI—but the fact that producer price inflation stopped rising has allowed businesses to get a leg up on inflation. It affords them “breathing room” to adjust their organization to an elevated inflation rate. They slim down their cost structure and reorganize work in pursuit of efficiency gains. They search for cheaper inputs. 

All in all, this allows them to moderate price hikes, or even stop raising prices. 

Another explanation for the slight drop in inflation is found in gasoline prices. When money is tight, people cut down on driving, which in turn puts downward pressure on gasoline prices. 

The average price for a gallon of gasoline fell from $5.03 in June to $4.67 in July. This decline is not spectacular, but it helps dampen overall inflation in the economy.

Now: if this drop had been the result of booming oil production, it would have been a net injection of confidence and purchasing power into the economy. Sadly, it is not: according to the BEA, inflation-adjusted gasoline consumption fell by 3.3% from June to July. This is the biggest decline for the month of July in at least 20 years. It is in fact a big enough drop to affect gasoline prices. 

All in all, the U.S. economy shows no clear signs of a recession. That will change if inflation remains high, which—all other things equal—it likely won’t. 

But what about Europe? Stay tuned for Part II.

Sven R. Larson is a political economist and author. He received a Ph.D. in Economics from Roskilde University, Denmark. Originally from Sweden, he lives in America where for the past 16 years he has worked in politics and public policy. He has written several books, including Democracy or Socialism: The Fateful Question for America in 2024.

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