A Look at the Current Recession, A Signpost for the Start of Recessions & Some Thoughts on the Likelihood of a Double Dip
by Mike Kimel
Cross posted at the Presimetrics Blog.
A Look at the Current Recession, A Signpost for the Start of Recessions & Some Thoughts on the Likelihood of a Double Dip
These days there’s a lot of talk about whether the recession is going to double dip. And frankly, there’s a lotta yadda yadda, some bad news, and some not-so-bad news. You’ve heard it all before, you don’t need to hear it again from me, and frankly, I’d like to take a different approach. Before launching in, links to all data sources will be provided at the bottom of the post.
Let’s get started with a look at the pace of recoveries from recessions and how the current one compares to others. The graph below shows the percentage change in real GDP per capita each quarter from the end of a recession. Every recession since 1947, the first year for which quarterly data is available, is depicted.
Figure 1
The graph makes a few things apparent. First, it is clear that the double dip or no double dip, the current recovery is pretty feeble. Second, the most recent recoveries have all been pretty feeble.
Things look even worse when one looks at recoveries from deep recessions:
Figure 2
Part of this feebleness is no doubt due to the government’s policies. As I’ve noted before, the data shows that when tax rates were cut during or right after a recession, recoveries were slower and shorter. And both GW and Obama were happily cutting taxes of one sort or another during the latest recession. And of course, the government spending they threw on as a stimulus was in large part ill-conceived, going to benefit primarily some of the parties most responsible for the meltdown, buying toxic assets at inflated prices, and trying to prop up housing prices that should have been allowed to fall.
But what’s there is there. The question du jour is double dips – is the economy going to fall into another recession so quickly after coming out of the previous one, as occurred in 1981, or repeated times in the 1920s?
To answer that question, we need to know what causes recessions. While the academic literature has some complex explanations which depend on all sorts of odd assumptions, I think the answer is simple. The following graph shows the 12 month percentage change in real M1 per capita in the month that a recession begins. M1 is simply the narrowest of the Fed’s measures of the money supply (cash, money in checking accounts, and traveler’s checks), and I’ve adjusted it for inflation and population. Note that the Fed from 1947 to 1958, the Fed doesn’t report M1, but it does report “money stock” which is sufficiently similar to use in its place.
Figure 3
Notice that every recession except one, the one that began in July of ’53, began after the Fed reduced the real M1 per capita by at least 2%. That’s enough to suggest that the change in real money supply per person may well matter; no certainty, but it’s a suggestion.
Assuming for the moment that real M1 per capita does matter, notice that the twelve month change in that variable through June of this year is about 2.8%, which doesn’t make it look an awful lot like a recession about to begin, even if (to repeat the points of Figures 1 and 2) the recovery is crummy.
But the graph also suggests that the theory needs something in order to be complete – it needs to be improved in order to explain July of ’53. What happened then? The big event at about that time was the wind-down from the Korean War. Another way to look at it… real government spending was about to start dropping a lot. Additionally, the very next month, the 12 month change in real M1 per capita went negative, and it stayed negative through the duration of the recession.
Call a drop in real M1 per capita a necessary but not sufficient condition for a recession, at least so far. Now, it is quite possible, pace Rogoff & Reinhart that this time it will be different. I would imagine that the way the Fed has put money into the economy lately, essentially giving freebies to badly run financial institutions, is not quite as useful as its usual M.O. In that case, it might take more than just being on the positive side of the real M1 per capita ledger to make a difference. And check out where that variable is going, anyhow:
Figure 4
It’s down quite a bit… but still it is positive. Can that number go negative in a hurry? Ayup. But the last bit of information we’ve had doesn’t seem to show that.
So what’s the conclusion? I’ve never had much of a problem going out on a limb. Back in March of 2008 I had my first few posts discussing the recession we were in, at a time when the consensus was that we weren’t in one. And check out the comments when I claimed, back in December of ’08 real GDP per that the recession would be over in the first half of the year. (Yes, I know, the post went up in January. And yes, I know the NBER hasn’t called the end of the recession yet but real GDP bottomed out in the second quarter of ’09.) This time, I’m not as comfortable; given where and how the Fed has been putting Money I just don’t see increases in the real money supply as being quite as effective as normal. The money is going to fill in a big hole the financial industry created in its collective balance sheet, and isn’t necessarily leading to a lot of additional spending. Furthermore, with all the talk of austerity, it wouldn’t be surprising if the Federal Government starts cutting back on spending.
So I’m just not sure. But as often as not, when things are bad enough for everyone to see a problem, they’re not as bad as most people think. Given that the weight of the evidence seems almost equally balanced on both sides, this little thing tips it slightly for me: unless and until the Fed starts removing money from the system, I don’t think we’re going into a second dip. But given the Federal Government’s current policies, I don’t expect much more than mediocre growth for the next few quarters either.
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Data Sources
FRED, the Federal Reserve Database, was the source for most of the data used to compute real M1 per capita: population from 1952 to the present , M1 from 1958 on and M1 from 1958 on.
Quarterly data on real GDP per capita and population. Note – the quarterly population figures were used to extrapolate monthly population for 1947 to 1952.
Finally, money stock figures were substituted in for M1 from 1947 to 1957. Those were copied by hand from this document at the Federal Reserve of St. Louis’ FRASER archives
Mike Kimel
a couple of facts that may be worth considering:
1. it is possible that the causality goes the other way. if we view M1 as a signifier for demand for money or as a sign of the strength of individual balance sheets, then it may be that the decline in M1 is a symptom of impending recession, not a cause. such data is further clouded by changes in saver behavior ans savings and money market accounts become both more common and easier to switch funds in and out of. i would not be surprised to learn that internet banking and ATM proliferation shifted a fair bit of money from M1 to M2 in recent decades. clearly, the monetary response to this downturn has been unpreceedented in its size and scope, so that may be a reason that M1 did not drop this time around, though the severity of the recession anywat does make me more suspicious that money supply is more of a symptom than a cause in this recession. obviously, the relationship goes both ways and is non linear, but very loose money for the last decade has built up large imbalances and debt levels that will make prining money a less effective driver of GDP in the near term. you cannot push on a string.
2. real M3 is currently dropping at the fastest rate since the second world war. regardless of whether we view this as a cause or a symptom of ecomonic slowdown/recession, it’s a worrying sign. such contractions have previously presaged contractions with about 6-9 month lead time. given the muddy and manipulated monetary situation, if any time were going to be different, it would be this one, but it does seem anomolous to me that such a purportedly steep yeild curve is coincident with such a strong M3 contraction. one would expect the opposite.
“unless and until the Fed starts removing money from the system, I don’t think we’re going into a second dip. But given the Federal Government’s current policies, I don’t expect much more than mediocre growth for the next few quarters either.”
Maybe a Lost Decade or a Long Depression (Recession)?
Morganovich has an excellent point. The causality is reversed. Rather than a decline in M1 preceding the declared “start of recession” (as evidenced by declining GDP until 1978, and general indicators after), what is happening is that people are changing behavior. They are slowing economic activity. The then shows up as a decline in the demand and need for money. The biggest cause of a decline in M1 is not action by The Fed. It’s rather a decline in loaning activity by banks. Banks are not really reserve-constrained, contrary to the gold-standard inspired fairy tale of money creation explained in most econ 101 textbooks. Rather, loans are created (i.e. M1 created) first, then the reserves are created.
Morganovich has an excellent point. The causality is reversed. Rather than a decline in M1 preceding the declared “start of recession” (as evidenced by declining GDP until 1978, and general indicators after), what is happening is that people are changing behavior. They are slowing economic activity. The then shows up as a decline in the demand and need for money. The biggest cause of a decline in M1 is not action by The Fed. It’s rather a decline in loaning activity by banks. Banks are not really reserve-constrained, contrary to the gold-standard inspired fairy tale of money creation explained in most econ 101 textbooks. Rather, loans are created (i.e. M1 created) first, then the reserves are created.
Morganovich has an excellent point. The causality is reversed. Rather than a decline in M1 preceding the declared “start of recession” (as evidenced by declining GDP until 1978, and general indicators after), what is happening is that people are changing behavior. They are slowing economic activity. The then shows up as a decline in the demand and need for money. The biggest cause of a decline in M1 is not action by The Fed. It’s rather a decline in loaning activity by banks. Banks are not really reserve-constrained, contrary to the gold-standard inspired fairy tale of money creation explained in most econ 101 textbooks. Rather, loans are created (i.e. M1 created) first, then the reserves are created.
Since the 1990s I’ve used MZM (zero maturity money) rather than M1 as MZM is closer to what M1 used to measure before banks started paying interest on demand deposits and money market funds became a significant alternative to bank deposits.
Right now both nominal and real MZM growth is negative. Hopefully, as MZM velocity(personal income/MZM) is negatively correlated with real interest rates — as M1 velocity has also been– the recent drop in real rates can generate higher monetary velocity. MZM velocity looks like it may have just bottomed. But it still looks like MZM growth implies a significant slowdown if not a recession is on the immediate horizon.
I use MZM as a leading, concurrent indicator of the stock market PE and the S&P 500 PE has been falling almost constantly since September, 2009. A falling market PE is also generally a good, but not perfect, leading indicator of economic weakness
spencer-
i’m not so sure about that falling P/E as an indicator of impending economic weakness thesis.
im many cyclical situations, P/E is lowest at the top of the cycle (peak earnings) and highest at the bottom. in many cases, you can also get heavy shocks to P (like the russian debt crisis) that drive big market moves but have little economic significance here. the move since 9/09 has a great deal to do with earnings recovering from a terrible trough (especially in the financials). i’m not sure it has a great deal of predictive value at the moment.
my fear is that monetary policy is not really capable of getting us out of the current slump. decades of loose policy has led to overinvestment and over borrowing. there is no monetary solution to overcapacity and using massive money growth (and consequent inflation) to alleviate debt seems to me both a cure worse than the disease and terribly unfair as it benefits the profligate by punishing those who saved. (to say nothing of the moral hazard it creates)
this seems like it will be a long, slow recovery (and like a double dip/failure to call and end to the recession is possible). stimulus is unlikely to help because there is nowhere good to invest it in an economy that already has too much capacity and debt. i’m not sure velocity will increase all that much. i fear there may simply not be a great deal of demand for money.
it seems to me that the stubborn unemployment is being caused by another effect of the same debt issue. a key feature of the US labor market in comparison to europe has been labor mobility. we go where the jobs are. but, if you are underwater on your mortgage, it may be unaffordable for you to do so, rooting our labor force in place and most so in the areas that crashed hardest. this will make a return to full employment lengthier as well as oddly predictaed on home prices.
I think you have to consider that consumers are spending less and particularly are doing more and more of their spending out of disposable income rather than with credit, especially revolving credit. That cannot be ignored in any examination of a double-dip or another leg down of the existing recession (depending on ones viewpoint). If a critical mass of consumers, independently, refuse to participate then it will be consumers that take the economy over the next cliff.
Have we reached that critical mass yet? I don’t know. A Pew survey released July 1st showed that 62% of respondents had cut there spending during this recession. When you remove the top and the bottom who aren’t spending any more or less (generally) in the case of the former and are spending just about everything they have in the case of the latter what you have to look at is 62% is a very significant number.
If you examine what has happened with various incentives you see that any alterations of consumer behavior is temporary and consumer demand continues to fall off from it. Whether it is housing, autos, even groceries, we see tightening in any kind of spending and when you consider the C-4-C like program for buying appliances you find that it has had little impact at all. People are not spending anything on any items unless they absolutely have to.
The government has been playing extend and pretend based entirely on the idea that pent up demand in consumers would grow until it busted out and the recovery would be on – fueled by consumers. What has happened is the exact opposite. This is very serious. We are running into 3 years now, and 4 if you look at what commodity speculation did to consumers starting back in early 2007. Remember the prices for wheat and such that were even driving the price of pizza up 30% or more? And then we have such things as “staycations”. And so the concern should be whether or not we have a permanent shift in consumer behaviors. Three or four years is plenty of time to break old habits and establish new ones.
The longer this goes on the worse it gets for the economy at large. Consumers, or in the new vernacular Main Street, has been told repeatedly (indirectly) by the government that they are on their own. And while it shouldn’t shock anyone that when people are told they are on their own that they will act in their own best interests it seems to have the likes of Summers and the economic team dumbfounded, not to mention many other economists. In their actions of self preservation these individuals couldn’t care less about the macroeconomic impacts they cause nor do they care about whether it distorts models or renders predictive indicators unreliable or whether all of that leads to incorrect actions or reactions by the businesses or government. So long as business and government continues to treat this recession in terms of other recessions and expected or predicted behaviors everything will get worse rather than better.
morganovich,
A couple years ago I had a post on this, and as luck would have it, I was working on just this very thing at my day job today.
While there is some back and forth, playing with lags and correlations indicates that M1 leads.
I’m working off memory right now, but if I’ve got the figures right, the twelve month percentage change in real M1 per capita’s correlation with the twelve month percentage change in real GDP per capita lagged by 3 quarters is about 31%. I believe the reverse (i.e., lagging real M1 per capita by 3 quarters) correlation is about half of that going back to 1947.
The correlations aren’t that high precisely because there is causality going both ways, but as a first pass at least it seems money supply is wearing the pants.
Min,
I hope not. But realistically, Obama hasn’t picked the best advisors. Christy Romer’s tax views are informed by her “narrative history” work (which several of us here at AB have already critiqued) and doesn’t amount to anything different than Hubbard or Mankiw would recommend. So why would we expect things to turn out all that much better?
econproph,
See my response to Morganovich above.
Spencer,
I’d have to look into MZM in a bit more depth. That said, I’m always reluctant to switch series mid-stream unless there’s a slam dunk reason. The reason is not because series don’t change – they do, in spades – but rather because its hard enough to explain “real M1 per capita” without having to explain why you’re switching to something else in the middle. Sometimes “best possible analysis” has to take a back seat to “easy to explain.”
Mindrayge,
“I think you have to consider that consumers are spending less and particularly are doing more and more of their spending out of disposable income rather than with credit, especially revolving credit.”
No argument from me. Again, though, my focus is on the simplest model I can build that explains as much as possible. For my day job I might build something takes into account more variables, but for my purposes here, I’m trying to explain as much as I can as simply as I can.
mind-
might the reason that consumers are so reluctant to open their wallets be that they are too deeply in debt? this may not be a permanent shift in behavor, but rather the spending pendulum swinging back past center in the other direction.
deprived of home equity lines and saddled with mortgage and credit card debt, incremental money will need to be used to pay down the debt that resulted from consumption that already occured.
if such is the case, it has important policy implications as it would mean that additional “stimulus” in unlikely to drive much economic performance as the extra money will large go to pay down debt. this pay down of debt is a good thing and should be encouraged, but it means that in the near term, “stimulus packages” are going to be “spent” on spending that has already occured and therefore not drive much GDP, especially in an environment with overcapacity in so many industries.
there is no easy fix here. a debt based bust takes a long time to clean up. we have not had a serious one since the 30’s. i fear the best we can hope for in the next several years is a muddle through at below trend growth.
It is a policy thing. Nothing in policy is addressing under [lack of] capacity of the non war machine economy.
The US needs to shift from 8% GDP in socialized federal production to consumer capacity.
No policy (other than off shoring) for non war machine capacity so there is no growth trend to track.
Yes. Any stimulus is going to get right into savings mostly. That is what happened with almost all of both Bush Admin stimulus packages and much of the amount of stimulus that came out of ARRA.
And it is true there isn’t an easy fix. What is dragging this out and making the whole process destructive is that the government response (i.e. Summers, et al) has been extend and pretend based on the theory that there was pent up demand building and the consumer was going to drive the economy out of the gutter on credit cards. You can find, at various times but especially before 2010, in articles involving government sources (on the record or off) the use of the phrase “pent up demand”. That hasn’t materialized and I would hope by now that the government realizes it isn’t going to materialize any time soon. From all appearances there isn’t a plan B.
So, again, you are also correct that this will be a long drawn out process. This process is going to come with millions of more households being put through the bankruptcy and foreclosures wringer. This, along with the destruction of the millions of households already, is only going to destroy credit quality – already over 25% are subprime now – leaving people unable to borrow except at exceptionally high interest rates.
This will further choke buying power and destroy more businesses that are also playing extend and pretend waiting on the consumer. How long will they be able to keep rolling over debt or servicing debt that they have that was borrowed in anticipation of consumer spending rates much higher than they are getting? I expect that should any recovery try to take hold we will see quickly rising prices against stagnant wages and then quickly back into the consumer pulling back on spending.
The real question in this isn’t so much the economics of it because the longer this goes on the more it becomes a political problem. Not a political problem of which party’s platform or ideology but a political problem of the adversarial kind between the people and the government regardless of the parties involved. We are already to the point where just about anyone in the bottom 90 percent of the economic ladder either is or knows someone that has been long-term unemployed, been through foreclosure, or has been through bankruptcy. The longer this goes on the worse the optics get in that regard.
There are ways of turning things around much quicker but the top one percent crowd won’t like any of those solutions. However, if this drags on too much longer they won’t end up with too much say in the matter.