When future economic historians write of our times, the thrust will be that it was a time of transition. Generational changes are taking place in labor markets; rapidly changing technology threatens to disrupt everything; there’s a strong political push to restructure the energy sector for environmental reasons; and we face unprecedented peace-time fiscal imbalances and an exceptionally fluid international situation. “Post-pandemic” will take its place alongside the “post-war” and “post-Cold-War” modifiers in describing events.
The immediate consequence of this is widely divergent economic indicators that make it hard to discern economic trends. Since President Biden took office, it’s possible to spin the numbers as a golden age of Bidenonomic prosperity, or as a stagflationary disaster to rival the 1970s. To maintain partisan claims, both sides have had to change their stories.
For the first 30 months of the Biden administration, the supply side of the economy looked strong with rapidly growing industrial production and employment; but the demand-side indicators of economic health — gross domestic product, personal income and sales — were falling, and inflation seemed poised to get out of control. Administration spokespeople sounded like Reaganite supply-siders, and Republican critics like Keynesians.
A flashpoint dispute in the summer of 2022 occurred when the National Bureau of Economic Research refused to call a recession, despite two successive quarters of declining GDP. The NBER probably relied upon strength in employment and production, as well as the fact that gross domestic income was not falling. Republicans claimed Democrats were changing the definition of a recession to avoid telling people the bad news. The White House countered that two successive quarters of GDP decline had never been the official definition of a recession, merely a common rule-of-thumb.
In the third quarter of 2022, everything changed. Inflation began to fall and sales increased while personal income and GDP stopped declining. Employment gains continued and industrial production continued to grow, albeit at a slower rate. But now GDI — perhaps the major reason the NBER did not call a recession in 2022 — began to fall, with two successive negative quarters. GDI is now an all-time-high $379 billion less than GDP on an annualized basis (the percentage difference has been higher in the past, however). This is concerning because GDI is the more reliable recession predictor than GDP.
In theory, GDP and GDI measure the same thing — the total value of goods and services produced in a geographic area and sold to end-users at arms-length prices during a quarter — but in different ways. If the economy had a single cash register, GDP would measure the money coming into the till, GDI would measure where the money went — to wages, supplies, taxes, interest, dividends or left in the till for owners and stockholders. But since the economy has billions of transactions, many complex and not all captured in official numbers, GDP and GDI have different measurement errors, and thus different values. They’re usually pretty close, however, differing by 0.8 percent on average.
Using two successive down quarters as the signal for recession, from 1947 to 1973 GDP and GDI agreed all but once. They both signaled four recessions at the same times, and they both missed the 1961 recession. GDP did give one false alarm in 1947.
Since 1973, however, GDI has done much better. Four times it signaled recession before GDP and once it caught a recession that GDP missed. Twice the two triggered at the same time, and once GDP gave a false alarm.
There’s been more news recently suggesting that a recession began at the end of 2022. Second-quarter GDP growth was revised down. Job openings are plunging. The labor leverage ratio — the proportion of workers quitting to those let go by employers — is falling as well, suggesting workers fear a weak job market and have little power to get increased wages. Corporate profits are falling as well. If current trends continue, and if GDP declines a significant share of the roughly 1.5 percent needed to fall in line with GDI, the economic numbers released from late September through October could well prompt the NBER to announce a recession.
This has three main implications, two political and one economic. Politically, NBER declaring a recession would support the Republican story that the Biden administration hurt the economy and denied obvious economic reality for three years to push left-wing policies. It would make Democratic painting of Bidenomic prosperity seem hollow or even dishonest.
Of course, the economy is what it is, regardless of NBER pronouncements, so voters shouldn’t care much whether the economy is just over or just under some official recession line in the opinion of a committee of economists. We are, as I said before, in a time of radical economic transition and events cannot conform to simple patterns from the past.
The other political implication is that the Federal Reserve is looking at the same numbers as NBER, although it weights them differently and tends to prefer data that are available more frequently since it must act today to try to influence tomorrow, while the NBER is backward-looking. The numbers that would cause the NBER to call a recession are similar to the ones that would cause the Fed to cut rates — in fact, data to date have already cooled prospects for any Fed rate increases considerably. While the NBER has no formal influence over the Fed, the Fed will not want to announce a rate increase at the same time the NBER is calling a recession.
The economic issue is that recession is more than a word economists throw around. It’s an economic phenomenon during which the economy clears out its deadwood and restructures for the next round of growth. In this sense, it doesn’t matter what the NBER says, it matters how people act. Do households hunker down, keep jobs if possible and pay down debt? Do businesses hold off on expansion plans? Do innovators and entrepreneurs go into stealth mode, laying the foundations for success when good times return rather than trying for profits today? In a similar decision, do individuals go back to school, or stay in school, to build human capital for the future rather than finding whatever work they can today? We seem to have been poised on the edge of such decisions for over a year now, without either jumping off or stepping away from the brink.
In her novel King’s Mountain, Sharyn McCrumb wrote, “There is a time in late September when the leaves are still green and the days are still warm, but somehow you know that it is all about to end, as if summer was holding its breath, and when it let it out again, it would be autumn.” She could have been writing about people watching economic numbers in 2023. Are the economic leaves green with warm days ahead? Prudent investors would prepare for a September that begins an economic autumn, leading to winter.
Aaron Brown is a former managing director and head of financial market research at AQR Capital Management. He is author of “The Poker Face of Wall Street.” He may have a stake in the areas he writes about. Views are personal and do not represent the stand of this publication.
Credit: Bloomberg
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