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Why It's So Hard to Define a Recession

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What You Need to Know

  • Two consecutive quarters of decline in the gross domestic product is the unofficial definition of a recession.
  • Other common recession indicators, including inflation, mortgage rates and unemployment, are very mixed.
  • Whether or not we are officially in a recession, it is important for advisors to help their clients prepare for any potential weakness in the economy and the markets.

There is much controversy and discussion in the media as to whether or not we are currently in a recession, or even what defines a recession.

Let’s start with the definition of a recession. The traditional, though unofficial, definition is that a recession occurs when the economy experiences two consecutive quarters with a decline in the gross domestic product. This has in fact occurred; the GDP suffered a 0.9% decline in the second quarter on the heels of a 1.6% decline in the first quarter of 2022.

This definition of a recession is not official, however. Recessions are officially declared by an organization called the National Bureau of Economic Research. NBER’s Business Cycle Dating Committee says that “a recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months.”

As of yet, NBER has not declared that we are in a recession. it generally doesn’t declare a recession until a number of months after the fact, and thus that so far it has made no declaration that we are (or were) in a recession is not surprising.

Why Is There Controversy Over the Definition of Recession?

One likely reason for the controversy over the definition of a recession is that there is no definitive definition. The closest thing we have to an official declaration of a recession is from a group of academics who don’t declare we are in a recession until well after its onset.

Add to this the fact that the word “recession” is very politically charged, and you have all of the ingredients for controversy. Some politicians may say we are in a recession and seek to blame their political rivals for the state of the economy. As 2022 is a midterm election year, it’s likely we will see much of this until the November elections.

Beyond the lack of a hard and fast definition of a recession and the ongoing debate among politicians, economists and other financial experts as to what constitutes a recession and whether or not we are in one, the characteristics of each recession are a bit different.

For example, the last major recession spanning the 2007 to 2009 timeframe saw a severe downturn in the housing market and significant levels of unemployment. If we are indeed in a recession now, this would be perhaps the first recession marked by an uptick in the level of employment.

The recent July jobs report showed the economy added 528,000 jobs for the month, which eliminated the jobs lost during the pandemic.

So Are We in a Recession?

This is a bit of an ongoing debate among many parties in the media and elsewhere. For example, Federal Reserve Chairman Jerome Powell has indicated many times that he doesn’t think we are in a recession. He cites the strong job market as well as other areas of the economy that are doing well as indicators that the U.S. economy is not currently in a recession.

While there have been layoffs in the tech sector — including companies such as Shopify, Netflix and Robinhood — other sectors saw solid gains in employment levels elsewhere. The leisure and hospitality sector as well as the professional services sector in particular have recently reported significant gains.

The solid gains in employment, coupled with the low unemployment rate might indicate that we are not currently in a recession.

Another positive indicator is an increase in average hourly earnings of 0.5% in July, also up 5.2% from a year earlier. While the annual increase sounds impressive, the annualized rate of inflation came in at 8.5% in July, largely negating these wage increases.

With the continued strength in the job market, coupled with high inflation, many experts expect the Fed to keep hiking interest rates. Many consider the combination of inflation and higher interest rates to be the biggest threats to the economy and the factors that might drive the economy into a recession assuming we are not currently in one.

What Are the Other Indicators of a Recession?

The main indicator showing the economy is in a recession is the decline in the U.S. GDP for two consecutive quarters. While this has traditionally been the definition of a recession, in reality, it is just one indicator. Others include:

Stock market performance: The decline in the stock market so far in 2022 could also be construed as a recessionary indicator. Through the close on Aug. 8, the S&P 500 has declined more than 15% since the end of 2021. This is despite the recent rally in the market over the past couple of weeks.

Consumer sentiment: Some might also construe the marked decline in consumer sentiment as an indicator that we are in or near a recession. In a recent Bloomberg Opinion piece, Gary Shilling pointed out that the upswing in Google searches for the word “recession” is unto itself an indicator that a recession is increasingly likely.

Discretionary spending: Continued high inflation also may indicate that the economy is in a recession. High prices for food and gasoline were recently cited by retailer Walmart as a major factor forcing many of the chain’s shoppers to reduce spending on items such as clothing. The company reduced its profit outlook and has said it may be forced to discount prices on a number of discretionary spending items, such as furniture, in the near future. Reduced discretionary spending by consumers is often a symptom of an economic recession.

Mortgage rates: High interest rates, largely as a result of the Fed’s efforts to fight inflation, are beginning to take their toll on the previously robust housing market. While this may or may not be a recessionary indicator yet, higher mortgage rates are starting to have an impact on home sales in some areas of the country. Time will tell as to the impact of higher mortgage interest rates on the economy as a whole and the housing market in particular.

What Indicators Show the Economy is Not in Recession?

As mentioned previously, the robust job growth we saw in July would be an indicator that we are not in a recession. Many past recessions have been marked by high levels of unemployment and job loss. Currently, the unemployment rate stands at 3.5% after hovering at 3.6% for several months.

For example, the unemployment rate for the recession in the 2007 to 2009 time period peaked at 10% in October of 2009, several months after the end of the recession and about seven months after the bear market bottom that occurred in March of that year. During the brief recession following the initial onset of COVID-19, the unemployment rate peaked at 14.7% in April of 2020, the month after the recession officially ended.

Additionally, despite higher mortgage interest rates, the housing market in many areas of the country remains robust. This is generally not the case in most past recessions.

What Does This Mean for Clients?

Whether or not we are officially in a recession — or even what the official definition of a recession is — really doesn’t matter for your clients. What does matter is that you help them prepare for what might be a rocky period in the markets and in the economy.

  • Be sure their portfolio is properly allocated.
  • Ensure that your clients have sufficient liquid reserves in an emergency fund in the event they are affected by a downturn in the economy.
  • Work with them to keep their spending in check.

(Image: Shutterstock)