Predicting Recessions, The Great Stagnation, and Will There Be a Double Dip?
by Mike Kimel
Predicting Recessions, The Great Stagnation, and Will There Be a Double Dip?
There’s a lot of talk about a double dip recession these days. I don’t think there’s a precise definition of a double dip recession, but I think if there was it would be something like this: “a recession, followed by a recovery which doesn’t last very long, leading into another recession.” Given the official end of the recession occurred in June of 2009, if the current slow down is (or results in) a recession which gets labeled a double dip, that would imply a double dip recession is one that occurs no more than about two years after the previous recession ended.
By that standard, there’s only been one double recession in the last few decades – a recession began in July ’81, 12 months after the previous one ended. Before that, you have to go back to the supposedly “Roaring” 1920s, when you’ll find quite a few recessions coming back to back to back. You’ll also find multiple and large tax cuts, I might add. A cool graph of tax rates and recessions from 1920 to 1940 can be found here. Its really cool because the data just refuses to match up with what they’ve been teaching in econ classes for the past three decades.
Now, I was curious – how do you tell when you’re in a recession? (Long time readers may recall my frustration, having called both the start and end of the Great Recession in complete anonymity when I had a book to sell!. I guess the pay is better in being always wrong. The book, by the way, is still for sale and still provides a very different way of looking at the world that matches up with data very nicely.)
In this post, I want to stick to some of the traditional views. Basically, if you corner enough economists, you might get them to tell you recessions begin if there’s a big drop in private consumption, private investment, or gov’t spending. I hasten to add – that’s mostly investment in stuff, not in stocks and bonds. (Not all economists would agree with each of these items, I might add. So, let’s cut to the data and see what it shows. Data on real (inflation adjusted) private consumption and investment, and government spending is available from the BEA’s NIPA Table 1.16. Quarterly data goes back to 1947, and annual data goes back to 1929. (And please, please, please, don’t write to me about using some data set of suspect provenience developed decades after the fact. I don’t make up numbers, and I don’t use anyone else’s made up numbers either except when I’m pointing out problems with such data sets.) Recession dates come from the NBER.
Now, for every recession beginning with the one that started in October of ’48, I looked at the change over four quarters in real personal consumption, real private investment, and real gov’t spending through the quarter in which the recession began. For the recessions that began in May ’37 and February ’45, quarterly data wasn’t available, so I looked at the one year change in real personal consumption, real private investment, and real gov’t spending through the year when the recession began . The recession of 1929 was ignored because data began that year – hence, the one year change through 1929 is not available.
The table below indicates with an X if there was a drop in any of these three factors for any given recession.
As the table shows, five of the eight recessions between 1937 and 1973 were preceded by a cut in real gov’t spending. None of the recessions after 1973 were preceded by a government spending cut. On the other hand, cuts in private investment also preceded two recessions that occurred before 1973, and all but one (four out of five) of the recessions that came after that date.
So… before 1973, cuts in gov’t may have been responsible for some recessions, and reduced investment may have been responsible for most recessions since the 1970s. (If that break sounds familiar, it is more less where Tyler Cowen puts the start of his Great Stagnation, though as I’ve pointed out, Cowen’s philosophy doesn’t allow him to understand what happened to cause that Great Stagnation. My guess is this can be added to that list.)
In recent decades, big drops in private investment have often been portents of recessions. And if you’re wondering… according to the May update of Table 1.1.6 (link above), private investment (in 2005 dollars) reached a post-recession high of 1.855 trillion in the third quarter of 2010. It fell to 1.761 trillion in the fourth quarter of 2010, and 1.813 trillion in the first quarter of 2011. We won’t know for a while what happened in the second quarter of 2011, but… things are a bit shaky. Ironically, at this point in time, one thing that might shellac private investment is a big reduction in gov’t spending. Right now I think there’s a good chance we’re just going to skate along on feeble growth rather than an outright second recession, but its going to be near miss at best. Public confidence is really poor, and its easy to see how private investment might fall even further if the gov’t takes its ball and goes home. (As regular readers know, I’m a big deficit hawk so it hurts to write that, though I’d hope to see the gov’t spending to be done more rationally than it has been since the whole mess started in 2008.) Of course, it also would help if proper incentives were provided.
You have to consider the chances for a double dip in the context of the end of QE2.
My own view is that the primary channels for the effect of QE2 should be observed in inflation expectations, asset prices and the exchange rate.
1) Inflation Expectations
US Dollar Two Year Zero Coupon Inflation Swap
2) Asset Price
3) Exchange Rate
Trade Weighted Major Dollar Index
Note that from the day before Bernanke announced the likelyhood of QE2 at Jackson Hole to approximately 8 months later (the term of actual implementation) 2 year inflation expectations increased by 1.8%, the S&P 500 rose 30.3% and the value of the dollar fell 11.0%. The first can be taken as a proxy for nominal growth expectations, the second implies that household wealth increased by about $5 trillion and the third resulted in US exports becoming more competitive.
Note also that all of these indicators have shown a retrenchment (20%-34%) since peaking in late April or early May.
Is there reason to believe QE2 has had an effect on real final sales of domestic product (a proxy for aggregate demand) and employment?
Looking at the household data one will note that the bottom occurred in December of 2009. In the 18 months since a total of 1.8 million jobs have been added. During that time there have been two major spurts in job creation (separated by a period of job loss).
A) During January 2010 through April 2010, counting the population correction factor, 1.49 million jobs were created. (Approximately 66,000 of the jobs were temporary census workers added in the month of April.)
B) During December 2010 through March 2011, counting the population correction factor, 1.43 million jobs were added.
In each case the spurt in job creation followed an relatively strong quarter of real final sales of domestic product. During the entire recovery there have only been two quarters where the real growth rate in final sales of domestic product exceeded 1.1%: 1) the fourth quarter of 2009 (2.1%), and 2) the fourth quarter of 2010 (6.7%). Which leads me to real final sales of domestic product.
2) Real Final Sales of Domestic Product (real GDP less inventory change)
Estimates of the effect of the discretionary fiscal stimulus by Goldman-Sachs suggest that it added 0.5%, 2.3%, 1.9%, 1.8%, 1.6%, 0.5%, 0.0%, -0.5%, 0.0% to real growth in each quarter from 2009Q1 through 2011Q1 respectively. In the absence of the discretionary fiscal stimulus this suggests that real growth in final sales of domestic product would have been -4.4%, -2.1%, -1.5%, 0.3%, -0.5%, 0.4%, 1.7%, 7.2%, 0.6% in each quarter from 2009Q1 through 2011Q1 respectively.
Note that it is estimated that without the discretionary fiscal stimulus the real growth in final sales of domestic product would never have exceeded 0.4% prior to 2010Q3. The surge since then, particularily in 2010Q4 thus stands out.
I think this suggests that QE2 had a substantial though short lived effect on real final sales of domestic product and subsequently on employment. Given that the withdrawl of the discretionary fiscal stimulus is forecast to be a substantial and presistent drag on real growth for the remainder of this year, and that the benefit of QE2 appears to be mostly behind us, I am not sanguine about the prospects of the economy going foreward.
QE3 would be better than nothing. A more coherent way of implementing “unconventional” monetary policy, such as price level or nominal GDP level targeting would be better still.
Figure 1 will be posted as blogger allows.
“You have to consider the chances for a double dip in the context of the end of QE2.”
I agree. Re-read the last paragraph of the post. QE2 is not mentioned by name, but I think its apparent what potential reduction in gov’t spending I’m talking about.
Mike, please say it! Don’t expect us to intuit your meaning(s), as there is much going on regarding budget spending.
1973 recession was partial oil shock, I had to really plan getting enough gas for my big 8 cylinder and part paying down debt from climbing out of 70 recession.
Since Carter then only Bush I and Clinton worried (12 (a few of these years) of 31 years) about the debt.
1980 recession was wall st dumping Carter for paying down Vietnam debts.
The great recession is a replay of the great depression with a modest safety net.
How do we get out of this we are already at war with the world?
Time for rationing (read increased old age poverty, increased child poverty and declining health for the lower 4 quintiles) …………………………….
For the perpetual wars.
So long as we’re staying on the mainstream side, you might want to look further into the Chicago Fed’s National Activity Index three mos MA [CFNAI MA3].
w/much more in ‘Related Topics] section on right side of page.
“ Ironically, at this point in time, one thing that might shellac private investment is a big reduction in gov’t spending. Right now I think there’s a good chance we’re just going to skate along on feeble growth rather than an outright second recession, but its going to be near miss at best. Public confidence is really poor, and its easy to see how private investment might fall even further if the gov’t takes its ball and goes home. (As regular readers know, I’m a big deficit hawk so it hurts to write that, though I’d hope to see the gov’t spending to be done more rationally than it has been since the whole mess started in 2008.)“
That, I think, is what I mean.
Thanks. Somehow that’s an index I never really looked at.
“Given the official end of the recession occurred in June of 2009, if the current slow down is (or results in) a recession which gets labeled a double dip, that would imply a double dip recession is one that occurs no more than about two years after the previous recession ended.”
Nope. There is nothing in the labeling of a second dip that implies a time limit. Far closer to the mark would be “…that would imply a that one dip beginning as much as two years after the end of the first dip could still count as a double dip.” In addition, since recession is singular in the term “double-dip recession” there is (inguistically) no “previous recession” within the two-dip period. There is one recession, with two dips.
None of which matters a hoot. Output and employment go up, output and employment go down, and sometimes output goes up which employment goes down and vice versa. It’s what happens that matters. Slapping labels on them doesn’t change the outcome.
All this talk of recessions and double-dips is pointless because the terms are poorly defined an ultimately meaningless. GDP is a terrible metric to use for evaluating economic health because it ignores the fact that all our growth since 2008 has been fueled with irresponsible deficit spending. Do you really think you have a healthy economy when it takes deficits over 10% of GDP to generate weak GDP growth below 3%? At this point, the only way we can have a “recession” as defined by economists is if the political will to deficit spend is lost. That definition is intellectually dishonest…the economic decline that started in 2008 never ended and has just been papered over in the near term with printed money and borrowing that will just make the long term problems worse.
Actually, I’ve had a few posts on this going back before the 2007 recession began… I noted that the decline began in 2001. That said, a long decline has its periods of ups and downs. A measure is necessary. I am picking the most common one. If you want a different one, well, that’s a different post. There’s only so much I can cover in one short post.
There’s a big distinction between government spending and quantitative easing. I’d prefer it if they weren’t conflated.
Other than that I’m glad you agree.
You are correct. I have a vague recollection, though, of a post where I found a correlation between M1 creation and gov’t spending. Maybe I’m hallicinating. Maybe if time permits I’ll look into that sometime.
Thanks for sharing
The fact that you don’t like a particular treatment of the data or a particular label doesn’t make it “intellectually dishonest”. One might argue, in fact, that it is intellectually dishonest to call some common usage intellectually dishonest just because you don’t like it. One might.