Recently there has been quite a bit of news on recessions. Economists say we will be in a recession next year, and some say we will be in a recession following year. In this article I would like to explain how economists come up with their forecasts of recession.
What is a recession technically? Why do economists have different opinions, different forecasts and different conclusions?
How do we define a recession and what are its effects?
In technical terms, a recession refers to a period of significant decline in economic activity within a certain country or region. We see jobs fade and increases in unemployment.
A big factor affecting recessions is the negative economic growth relating to the country’s GDP usually for the duration of two consecutive quarters. The National Bureau of Economic Research (NBER) considers a lot more data when making its projection of when a recession may occur.
John Maynard Keynes, probably one of the most influential economists of the 20th century, had a theory that during a recession, people become worried about the economy and are reluctant to spend more money. This in turn creates a high number of layoffs, putting the economy in a downward spiral. Keynes said that the way to overcome this is to get the government to spend more on the economy, mainly infrastructure.
Keynes also argued that aggregate demand can tell a lot about the economy, and when it falls short, a recession may occur and many people will be without jobs.
From the Economist’s Point of View
Economists mainly focus on leading indicators which include the ISM Purchasing Managers Index, the Conference Board Leading Economic Index and the OECD Composite Leading Indicator. These are crucial for investors and business administrators to track and analyze because it can give imminent signs that a recession is likely to occur. While they aren’t always 100% accurate, these indicators provide highly useful information pertaining to the stability of an economy.
The NBER largely targets trends like real income, employment, industrial manufacturing and wholesale/retail sales. These are major determinants in an economy's potential to grow and flourish.
Another source for economists includes information published by the U.S. Census which collects statistics about the people, businesses and the economy. Examples of the information they collect are employment, housing starts and consumer expenditures. When unfavorable changes occur in this data, the onset of a recession may be in play. After all, economic growth is fueled by consumers, businesses and investors and the prominent role they play in keeping the economy afloat.
While troublesome, a recession is a normal part of the business cycle and is an event to be expected. The question is how do we respond to it?
The U.S.’s Experience With Recessions
The U.S. has seen 17 recessions throughout its history including the Great Depression. The first recession called the “Panic of 1797” resulted from a “bubble” that burst stemming from land speculation in which wealthy people invested in real estate, only to be put in debtors’ prison. One of the main causes came from the depreciation of currency.
The most recent recession and worst since the Great Depression was the Great Recession in 2008. This was the longest lasting recession since WWII in which global financial markets as well as banking and real estate industries were devastated.
The result of this recession included a high number of home mortgage foreclosures and millions of Americans losing their jobs and hard-earned life savings.
During this time, Real GDP fell 4.3% and unemployment rose from 5% in December of 2007 to 10% in October of 2009. Needless to say, no one would like to see a repeat of this and the damage it caused millions of Americans.
Is There a Recession Coming Soon?
With speculation of an incoming recession, many people are concerned and are pondering how to prepare for such an event. On August 14th, the Dow Jones Industrial Average dropped 800 points which was its worst day this year. While President Trump is insistent that our economy is strong and such claims are being blown out of proportion, not everyone is on board.
Ongoing trade wars with China seem to be a big part of the problem. We’ve recently seen an escalation in the Sino-American trade and currency war with China. The President has threatened to impose more tariffs on Chinese exports in favor of domestic manufacturers, as mentioned in one of my recent posts.
In addition to this trade and currency war, there is also a technological cold war happening with the U.S. and China. There has been a competition over who is the dominant player in this industry.
Technology such as AI, 5G and robotics seem to be at the forefront of this feud. A Chinese multinational technological company called Huawei conducts a lot of research in 5G and its capabilities of bringing faster connectivity and large amounts of information.
5G can largely improve the efficiency of how businesses and the military operate for example. The capacity of this technology can be a big national security threat to Chinese consumer-goods exports.
With these ongoing tensions, negative supply shocks can lead to an increase in the price of imported goods and can decrease consumption and capital expenditures which in turn will lead to deglobalization.
Why Can’t Economists Come to the Same Conclusion?
About 3 out of 4 economists are concerned that we may see a recession come at least by the end of 2021, possibly earlier.
According to a survey from the National Association for Business Economics, which was conducted in a little less than a month, 38% of those surveyed believe that a recession will begin in 2020 while 34% believe it will hit in 2021.
One of the most accurate ways to forecast a recession is the inverted yield curve, which has come before every recession in the American economy since 1955. This curve illustrates that when the demand for long-term bonds increases, their yield decreases and therefore, the yields on short-term bonds are higher which results in an inverted yield curve. This indicates that people are worried about the health of the economy.
A number of economic analysts say that reaching a trade agreement would be one of the best solutions in prolonging America’s economic well-being. The question for most economists is not if there will be a recession, but when.
There are economists who also say that the possibility of us going into a recession will be determined by the American consumers like you and me, who’s spending accounts for nearly 70% of economic growth. This is a large number and shouldn’t be ignored.
With the wide range of data, statistics and opinions, there is no way that everyone will come to a consensus about a recession occurring and when, but it is important to stay updated on the changes in our economy and the many factors that come into play.