It is hard to pinpoint an exact definition of a recession as economists look at the overall impact on the economy when deciding whether there is a recession. They’ll look at factors like industrial production, the GDP, average incomes, the labor market, and consumer spending. Without a clear definition of a recession, many people use a general rule of thumb of 6 months in a row of significant decreases in GDP. Let’s explore how you can know if the economy is experiencing a recession.
Who Defines Recessions?
In the US, the unofficial authority on recessions is the Business Cycle Dating Committee of the NBER. When determining whether the economy is in a recession, they examine factors like:
- Industrial production
- Payroll employment
- Real consumer spending
- Real personal income minus government transfers
The Business Cycle Dating Committee’s 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.”
The most recent recession, the Covid-19 recession, is a prime example of this definition of a recession. It only lasted for two months, which would not be long enough to be a recession under the 6-month duration definition of a recession. However, the Business Cycle Dating Committee decided it was a recession because of the huge impact it had on the economy. In that sense, there is a lot of room for discretion and independent judgment in the definition of a recession.
Identifying businesses that are most resilient to economic downturns can help individuals and investors make informed decisions during uncertain times.
Economic Metrics and the Definition of a Recession
Let’s take a closer look at those economic factors that the NBER Business Cycle Dating Committee look at when determining whether the economy is experiencing a recession or not. While the committee looks at overall economic performance, they have confirmed that in recent years, they have confirmed that their definition of a recession gives more weight to payroll employment and real personal income, less government transfers.
1. Industrial Production and the Definition of a Recession
During a recession, industrial production can often change. As raw materials, manufacturing, and logistic costs rise, so too do business expenses. In order to reduce their costs and protect their profit, businesses will often slow down production. This economic indicator provides the definition of a recession with information on how businesses are feeling the pinch of economic decline and how they are responding to it.
2. Payroll Employment and the Definition of a Recession
A popular alternative definition of a recession, the Sahm Rule, states that when the average 3-month unemployment rate rises by 50 basis points compared to its lowest point in the previous 12 months, that is an indicator of a recession. The NBER don’t look at unemployment rates. Instead, they look at payroll employment, which gives them a much more holistic figure. Unemployment rates only show what percentage of people who are otherwise able to work are currently unemployed. Payroll employment will also factor in reduced hours and reduced salaries into the definition of a recession.
3. Real Consumer Spending and the Definition of a Recession
As individuals start to feel the pinch (through either rising cost of living, unemployment, or reduced earnings), they will reduce their spending. This economic metric gives the definition of a recession and information about how consumers are reacting to the economic decline. Among other strategies, as part of their recession recovery plan, the US government will try to stimulate consumer spending. This often takes the form of stimulus checks, rebates, grants, etc.
4. Real Personal Income Less Government Transfers
Real personal income, less government transfers, has become a critical factor in the NBER’s definition of a recession because it essentially indicates a person or household’s disposable income. It gives the definition of a recession data about both changes in the cost of living and whether consumers have income to spend after all their bills are paid.
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