INSIGHTS

WHEN A RECESSION IS NOT A "RECESSION"

Ed Peters
|
April 13, 2022

In my last post, I noted that the definition of a recession is not as precise as people think. The rule of thumb is two quarters of negative GDP growth. Yet, the decline in 2020 only lasted two months, March and April. So what gives?

The two quarter definition is actually a simplification of the National Bureau of Economic Research (NBER) approach to defining recessions. The New York Times used and popularized this definition in an article published in December 1974.1 But it also listed a number of other criteria that have since been forgotten:

1) Two quarters of negative “real” GDP growth,
2) A decline of at least 1.5% in real terms,
3) A two point rise in unemployment to at least 6%, and
4) A decline in employment in at least 75% of industries over a period of 6 months.

The author of that article admits that this list is a “rough translation.” Perhaps most important is the emphasis on “real” growth, which factors in purchasing power. If the economy grows at 5.5%, but inflation is at 7%, that is -1.5% in real terms. But the public seems to have latched onto a two quarter definition as gospel and seems to confuse it with a nominal decline.

I’m concerned that many pundits are throwing around a cavalier, over-simplified definition of a recession, since the two quarter rule is only one of a set of criteria. 2020, for example, did not meet the two quarter rule, but it was definitely painful, which shows how inappropriate it is to use this one criterion as a definition.

In the end, these “rules of thumb” are not real definitions. And the financial industry is full of them. That should be remembered as the inevitable debates on whether we will or will not have a recession ensue.

And by the way, the NBER only classifies US recessions, and things have likely changed since 1974. Other countries and regions define it differently.

Endnotes
1https://www.nytimes.com/1974/12/01/archives/the-changing-business-cycle-points-op-view.html

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