Econ 101: What does 'Recession' Mean?

     Amy Robach, a daytime anchor at MSNBC, recently reported on the “Today” show that “everyone’s talking about a recession.” The Business and Media Institute found that the broadcast media mentioned the economy or a recession in 54 stories during the first two weeks of 2008.

     When I was a child, one of the most popular shows on children’s television was the “Rocky and Bullwinkle Show.” In one of the segments, Bullwinkle Moose played Mr. Know-It-All. His opening line always ended with “Now what does that mean?” Perhaps it is time we asked the same question about recession.

     There are a number of economic terms television anchors use that probably neither they nor their audiences really know how to define.

     For example, we hear “The economy grew by 2.1 percent last quarter.” That takes for granted everyone knows what this means. But what do we mean by “the economy” that we are somehow measuring? Economists understand that the reporter must mean that GDP, gross domestic product, rose by 2.1 percent. But what is GDP?

     Gross domestic product is the value of all final goods and services produced in an economy in a given year. By final goods we mean goods that are not transformed into other goods. For example, if we made $100 of wheat but that was turned into bread that sold for $300, we can’t count both the wheat and the bread. So GDP would include the bread as a final good.

     Also note that goods are measured according to their value in the market. Goods or services which are not bought and sold, such as a father driving his son to a soccer game, are not counted. If the father hired you to drive his son to the game, then that would be counted. “Real GDP” takes account of the effect of inflation on the values of goods, as opposed to “nominal GDP.”

     Now that we know what GDP is, we can tackle what we mean by recession. A recession, as defined by the Business-Cycle Dating Committee of the National Bureau of Economic Research (The Committee), is “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

     This definition, by the body that officially determines recessions for the United States, is somewhat broader than you will find in intermediate macroeconomics textbooks. Two of the more popular books are by Robert Barro and Gregory Mankiw. Barro defines recession as “a period of decline in real GDP or a shortfall of real GDP from trend.” Mankiw defines a recession as “a sustained period of falling real income.”

     The business community often refers to a recession as a period of two consecutive quarters of decline in real GDP. This will generally follow the identification scheme of the Business-Cycle Dating Committee, but may not always. The Committee also considers the depth of the decline, and uses more indicators than just real GDP. However, a period of six months of declining real GDP will generally be classified as a recession.

     There are a few things to notice about the definition of a recession. First, it is not a slowing of growth of GDP. The Committee puts it this way: “It’s more accurate to say that a recession – the way we use the word – is a period of diminishing economic activity rather than diminished activity.”

     Hypothetically, if real GDP grew by 4.9 percent in the third quarter of 2007 and grew by 1.0 percent in the fourth quarter, then we were not in the beginning of a recession in the fourth quarter. The average forecast of economists surveyed recently by The Wall Street Journal was .9-percent real GDP growth for the first quarter of 2008 and 1.2 percent for the second quarter. This means that we are probably not in “a significant decline in economic activity.” We may be growing more slowly than we were in the first part of 2007, but those numbers would not indicate we are not in a recession.

     A second point is that real GDP is not reported in a timely fashion. It is reported with a lag, and then changes are often made – sometimes significant ones – as time goes on. This means that we don’t know officially if we are in a recession until we are long out of it.

     The average post-World War II recession lasted 10 months. That was not enough time to declare we were in a recession before we were out. Indeed, the last recession, from March 2001 to November 2001, was announced with a substantial lag. The Committee announced the March 2001 peak in real GDP on Nov. 26, 2001, and in July of 2003 determined that the end of the decline in real GDP had occurred in November of 2001. So it was as eight months’ lag before the Committee declared we were in a recession, and a 20-month lag before it declared the end of the recession.

     Obviously, the purpose of the Committee is not to forecast. Rather it is to precisely date recessions so researchers can attempt to figure out how to dampen business cycles. This means that declarations of recession are always forecasts that rely on art as well as science. Finally, we can be fairly certain that, although the economy is not growing as fast as it was, we are not in a recession. Perhaps the media would benefit from answering Mr. Know-It-All’s query.

Dr. Gary L. Wolfram, a Business & Media Institute adviser, is the George Munson Professor of political economy at Hillsdale College in Hillsdale, Mich.