EXPLANATOR: How do we know a recession has started?

WASHINGTON– The Federal Reserve sent a sobering message on Wednesday after announcing its latest big interest rate hike: it plans to keep raising rates for as long as it takes to beat the worst bout of inflation in decades. decades, even at the risk of causing a recession in the process.

The aggressive pace of its rate hikes will make it increasingly expensive for consumers and businesses to borrow and spend. Job cuts and rising unemployment could follow. And eventually, as the job market steadily weakens along with the economy, a recession could ensue.

Given the strength of the job market – the unemployment rate is still extremely low at 3.7%, with many job vacancies – most economists say a recession looks months away, at least. But most of them nevertheless believe that an economic slowdown is inevitable.

Late last month, the government updated its estimate of the performance of the economy in the April-June quarter and confirmed its earlier estimate that the economy had contracted for two consecutive quarters.

Six months of contraction is a long-standing informal definition of a recession. However, nothing is simple in a post-pandemic economy where growth is negative but the labor market is solid. The direction of the economy has baffled Fed policymakers and many private economists since growth came to a screeching halt in March 2020 when COVID-19 hit and 20 million Americans were suddenly laid off.

Even as the economy contracted in the first half of this year, employers added 2.7 million jobs – more than in most entire years before the pandemic hit. In August, the economy added 315,000 more. The unemployment rate, at 3.7%, is barely above a half-century low. Robust hiring and extremely low unemployment are hardly compatible with a recession.

Inflation, meanwhile, remains near its highest level in four decades, although gas costs and other prices have come down in recent weeks. Inflation is still so high that despite the wage increases many workers have received, Americans’ purchasing power is eroding. The pain is felt disproportionately by low-income households and Black and Hispanic households, many of whom struggle to afford more expensive essentials like food, gas and rent.

Compounding these pressures, the Fed is raising rates at the fastest pace since the early 1980s, increasing borrowing costs for homes and cars and credit card purchases.

So how do we know exactly when an economy is in recession? Here are some answers to these questions:

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WHO DECIDES WHEN A RECESSION HAS STARTED?

Recessions are officially declared by the obscure National Bureau of Economic Research, a group of economists whose Business Cycle Dating Committee defines a recession as “a significant drop in economic activity that spreads across the economy and lasts more than a few months”.

The committee views hiring trends as a key metric in determining recessions. It also assesses many other data points, including indicators of income, employment, inflation-adjusted spending, retail sales, and industrial production. He places great emphasis on jobs and an inflation-adjusted income gauge that excludes government support payments like Social Security.

Yet the NBER typically doesn’t declare a recession until well after it begins, sometimes up to a year. Economists consider a half-point rise in the unemployment rate, averaged over several months, to be the historically most reliable sign of a slowdown.

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DO TWO CONSECUTIVE QUARTERS OF ECONOMIC CONTRACTION EQUAL TO A RECESSION?

It’s a general rule, but it’s not an official definition.

Yet in the past it has been a useful measure. Michael Strain, an economist at the right-wing American Enterprise Institute, noted that in each of the last 10 times the economy has shrunk for two consecutive quarters, a recession has occurred.

Yet many economists doubt that we are currently in a recession. On the one hand, there is the robust labor market. On the other hand, Americans continue to spend, albeit more tepidly. Although purchases of goods like appliances and furniture have plummeted, spending on services like air travel and dining out continues to rise, indicating that millions of consumers are venturing more.

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DO MANY PEOPLE THINK A RECESSION IS COMING?

Yes, because many people now feel more financially burdened. With wage gains below inflation for most people, rising prices for essentials such as gas, food and rent have eroded Americans’ purchasing power.

Walmart reported that rising gas and food prices forced customers to cut back on purchases of discretionary spending such as new clothes, a clear sign that consumer spending, the main driver of the economy, is slowing down. weaken. The nation’s largest retailer, Walmart, cut its profit outlook and said it should cut more items like furniture and electronics.

And the Fed’s rate hikes have helped push the average 30-year fixed mortgage rate above 6% from below 3% a year ago, making buying a home more more unaffordable.

Higher rates will likely weigh on companies’ willingness to invest in new buildings, machinery and other equipment. If companies reduce spending and investment, they will also start to slow down hiring. The growing caution of companies to spend freely could eventually lead to layoffs. If the economy were to lose jobs and the public grew increasingly fearful, consumers would cut spending further.

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WHAT ARE SOME SIGNS OF AN IMPENDING RECESSION?

According to economists, the clearest signal that a recession is underway would be a steady increase in job losses and rising unemployment. In the past, an increase in the unemployment rate of three tenths of a percentage point, averaged over the previous three months, meant that a recession would soon follow.

Many economists monitor the number of people filing for unemployment benefits each week, which indicates whether the layoffs are getting worse. Weekly jobless claims have fallen to a four-month low, meaning amid a labor shortage, few employers are resorting to layoffs.

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OTHER SIGNALS TO WATCH?

Many economists also watch changes in interest payments, or yields, on different bonds for a signal of recession known as an “inverted yield curve.” This happens when the yield on the 10-year Treasury falls below the yield on a short-term Treasury, such as the 3-month Treasury bill. It’s unusual. Normally, longer-term bonds offer investors a higher return in exchange for tying up their money for a longer period.

Inverted yield curves usually mean investors are anticipating a recession that will force the Fed to cut rates. Inverted curves often predate recessions. Yet, it can take 18-24 months for a downturn to occur after the yield curve inverts.

For many weeks, the two-year Treasury yield has exceeded the 10-year yield, suggesting that markets are expecting a recession to come. Many analysts say, however, that comparing the 3-month yield to the 10-year yield has a better record when it comes to predicting recession. These rates are not reversed now.

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WILL THE FED KEEP HIKING RATES EVEN IF THE ECONOMY SLOWS?

Flashing signals from the economy – slowing growth with strong hiring – put the Fed in a difficult situation. Chairman Jerome Powell is aiming for a “soft landing,” in which the economy weakens enough to slow hiring and wage growth without causing a recession and bringing inflation back to the Fed’s 2% target.

But Powell acknowledged that such a result has become more difficult to achieve. Yet on Wednesday, he made it clear that the Fed would continue to raise rates, even amid a weakening economy that could slide into a recession, if that’s what is needed to get inflation under control.

“No one knows if this process will lead to a recession, or if it does, how big that recession would be,” Powell said at his press conference. “It’s going to depend on how quickly we reduce inflation.”

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