Let’s Quit Calling It Recovery

So today we learned that the “recovery” wasn’t quite as strong as we originally supposed. In fact, when you dig through the numbers it didn’t amount to much at all.

First, the facts. Third quarter GDP growth was downgraded from 3.5% (the initial estimate) to 2.2%, the current estimate. In between, it temporarily was placed at 2.8%. To add salt to the wound, the contribution from automobile sales is estimated to account for 1.45 percentage points of the 2.2% (link). Remember Cash For Clunkers? Without that artifice we would have seen growth around 0.75%. That in a quarter when fiscal stimulus was starting to stream into the numbers.

Let’s quit calling it recovery. We are in the throes of a very deep recession, the likes and type of which we have not seen before. We may even be in a depression but won’t recognize that fact until the historians describe it thusly several decades from now. The point to keep in mind is that all of the talk of recovery is really just definitional. We have stopped shrinking ergo we must be recovering.

Richard Posner had some excellent thoughts on this line of reasoning:

But the really important question is when a recession ends. The media regard it as ending when GDP stops falling; the economists when it starts rising. Both definitions are misleading, as the statistics of the current situation show.

For simplicity, assume that GDP in 2007 was 100. In 2008 it was less than four-tenths of one percent greater: hence 100.4. In the first quarter of 2009, it fell at an annual rate of 6.4 percent: that is, it declined by 1.6 percent. In the second quarter, just ended, it declined at an annual rate of 1 percent, which means that it fell .25 percent that quarter. Hence, by the end of July, GDP was 98.55, compared to 100 in 2007. Suppose it is flat in the third quarter of this year and rises at an annual rate of 1 percent in the fourth quarter (i.e., it rises by .25 percent–approximately; I am doing some minor rounding). (I am not forecasting; these are hypothetical numbers.) Then GDP for 2009 as a whole would be 98.8. That looks like a small decrease since 2007. But this ignores the GDP trend line. GDP grows at an inflation-adjusted rate (all my numbers are inflation-adjusted) of about 3 percent a year on average. Hence GDP in 2008 “should” have been 103 and 106 in 2009. At 98.8, therefore, it would be 7.2 percent below trend. Nonetheless, most journalists, economists, and government officials would say, given my numbers, that the recession had “ended” in either the third or fourth quarter of 2009.

By the same token, the Great Depression ended in 1933, when GDP began to rise, though when it began GDP was a third below its 1929 level and unemployment was at 25 percent.

It seems to me that a better definition–one that would give a more realistic picture of the business cycle–would be that a recession (or depression) ends when GDP returns to (or near) its trend line. Until that happens, the economy is in trouble and measures to speed recovery should continue to be considered. Otherwise, when GDP begins to grow, however modestly–or even when it just stops falling–people will say: the recession is over, so let’s forget about the economy for a while, even if unemployment is still growing, foreclosures are increasing, defaults and bankruptcies are increasing, and, in short, the economy is performing in a completely unsatisfactory manner. Maybe nothing can be done at that stage but let economic “nature” take its course; but complacency and false optimism should be avoided.

By definition we are in a recovery mode, but as Posner points out by that measure the Depression ended in 1933. There is much more to this economic episode that is yet to play out and there is little relief throughout the land despite the pundits pronouncements that recovery has commenced.