When GDP growth slows and extreme volatility plagues the market, we are often confronted with a familiar question…are we headed for a recession or are we already in one? The usual definition of a recession may make it seem clear-cut: two consecutive quarters of contracting GDP. However, to the “recession referees” of the National Bureau of Economic Research’s Business Cycle Dating Committee, the real definition is a little more nuanced.
The NBER’s traditional definition of a recession is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” It is important to note that the NBER’s Business Cycle Dating Committee is inherently backward looking. In other words, as they conduct post-mortem research, they are able to clearly define recessionary periods based on hundreds of data points. Put bluntly, the NBER is not in the business of forecasting or calling “in the moment” recessionary activity. For instance, the NBER’s determination of the trough date in April 2020 occurred 15 months after that date, in July 2021. In other periods, the NBER’s recession determinations took between 4 and 21 months after the trough.
The financial media often states the definition of a recession as two consecutive quarters of falling real GDP. Most of the recessions identified by the NBER’s process do consist of two or more consecutive quarters of contracting real GDP, but not all of them. In 2001, for example, the recession did not include two consecutive quarters of decline in real GDP. In the recession from the peak in December 2007 to the trough in June 2009, real GDP declined in the first, third, and fourth quarters of 2008 and in the first and second quarters of 2009.
In addition to slowing growth, the NBER examines the economic environment through three lenses: depth, diffusion, and duration.
The Business Cycle Dating Committee’s view is that while each of the three criteria—depth, diffusion, and duration—needs to be met individually to some degree, extreme conditions revealed by one pillar may partially offset softer indications from another. For example, in the case of the COVID panic in 2020, the NBER concluded that the implosion of activity had been so great and so widely spread (diffused) throughout the economy that the downturn should be classified as a recession even though it proved to be quite brief (short duration).
Because a recession must negatively influence the broad economy and not just be confined to one cyclical or troubled sector, the committee emphasizes economy-wide measures of economic activity. These include metrics like real personal income less transfers, nonfarm payroll employment, employment as measured by the household surveys, real personal consumption expenditures, wholesale-retail sales adjusted for price changes, and business or industrial production. There are no set standards that dictate which data points are more important than others or how they are weighted in the NBER’s decisions. From the NBER’s website, in recent decades, the two measures they most heavily relied upon in their determinations were real personal income less transfers and nonfarm payroll employment.
With the first quarter contracting by -1.6%, and the second quarter now one day behind us, we’ll know shortly whether our economy contracted again. For now, consumer sentiment is at its lowest levels since the Great Financial Crisis and downward earnings revisions are growing more likely, so whether the NBER calls a recession or not is really a moot point.