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What does recession mean? GDP growth, unemployment, inflation all factor into how we define state of US economy

NEW YORK — The US economy has contracted for two consecutive quartersheightening fears that the nation is on the brink of a recession — if not already in one — just two years after the pandemic recession officially ended.

Six months of contraction is a long informal definition of a recession. However, nothing is simple in the post-pandemic economy. Its direction has puzzled Federal Reserve policymakers and many private economists since growth ground to a halt in March 2020 as COVID-19 broke out and 20 million Americans suddenly lost their jobs.

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. And the unemployment rate has fallen to 3.6%, near a half-century low. Strong hiring and extremely low unemployment are not consistent with a recession.

MORE: US economy shrank 0.9% last quarter, 2nd straight decline, raising recession fears

While most economists — and Fed Chairman Jerome Powell — have said they do not believe the economy is in a recession, many increasingly expect a recession to begin later this year or next.

Anyway, with inflation raging at its highest level in four decades, Americans’ purchasing power is eroding. The pain is felt disproportionately by lower-income and black and Hispanic households, many of whom struggle to pay for higher-cost necessities like food, gas and rent. Exacerbating these pressures, the Fed raises interest rates at the fastest rate since the early 1980s, raising the cost of borrowing for homes and cars and credit card purchases.

As a result, regardless of whether the recession has officially begun, Americans have been increasingly hit by the economy.

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

Who decides when a recession has begun?

A recession is officially declared by the shadowy National Bureau of Economic Research, a group of economists whose advisory Committee on the Business Cycle defines a recession as “a significant decline in economic activity spread throughout the economy and lasting more than a few months.”

The committee views hiring trends as a key measure for determining recession. It also evaluates several other data points, including cash income, employment, inflation-adjusted spending, retail sales and factory output. It places a heavy emphasis on jobs and an inflation-adjusted income instrument that excludes government support payments such as Social Security.

However, the NBER usually does not declare a recession until after it begins, sometimes as long as a year. Economists consider a half-point increase in the unemployment rate, averaged over several months, to be the most historically reliable sign of a recession.

Do two consecutive quarters of economic contraction equal a recession?

This is a common rule of thumb, but not an official definition.

However, in the past, it was a useful measure. Michael Strain, an economist at the right-leaning American Enterprise Institute, notes that each of the last 10 times the economy contracted for two consecutive quarters, it resulted in a recession.

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However, even Strain isn’t sure we’re in a recession now. Like many economists, he notes that the key drivers of the economy — consumer spending, business investment, housing purchases — rose in the first quarter.

Total gross domestic product — the broadest measure of the country’s output — fell at an annualized rate of 1.6 percent from January to March due to one-off factors such as a sharp rise in imports and a fall in business inventories after of the holidays. Many economists expect that when GDP is revised later this year, the first quarter may turn out to be positive.

“The bottom line is that the economy is growing but still slowing, and that slowdown really accelerated in the second quarter,” Strain said.

Don’t many people think a recession is coming?

Yes, because many people now feel more financially burdened. With wage gains trailing inflation for most people, higher prices for essentials like gas, food and rent have eroded Americans’ spending power,

This week, Walmart said that higher gas and food costs forced shoppers to cut back on discretionary spending like new clothes, a clear sign that consumer spending, a key driver of the economy, is weakening. The nation’s largest retailer, Walmart, cut its earnings outlook and said it will have to discount more items such as furniture and electronics.

And the Fed’s rate hikes caused average mortgage rates to double from a year ago to 5.5 percent, causing a sharp drop in home sales and construction.

MORE: The Federal Reserve raised the key interest rate by 0.75%, another big hike in an effort to curb inflation

Higher rates will also likely weigh on businesses’ willingness to invest in new buildings, machinery and other equipment. If companies cut spending and investment, they will also begin to slow hiring. The growing concern among companies about discretionary spending could eventually lead to layoffs. If the economy lost jobs and the public became more fearful, consumers would cut back on spending further.

The Fed’s rapid rate hikes have raised the chance of a recession in the next two years to nearly 50 percent, Goldman Sachs economists said. And economists at Bank of America are now predicting a “mild” recession later this year, while Deutsche Bank expects a recession early next year.

What are some signs of an impending recession?

The clearest signal that a recession is underway, economists say, 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 was soon to follow.

Many economists track the number of people seeking unemployment benefits each week, which shows whether layoffs are worsening. Weekly jobless claims, averaged over the past four weeks, rose for eight straight weeks to nearly 250,000, the highest level since last November. While this is a potentially worrying sign, it is still a historically low level.

Are there other signals to watch for?

Many economists also watch changes in interest payments, or yields, on different bonds for a recession signal known as an “inverted yield curve.” This occurs when the yield on the 10-year bond falls below the yield on a shorter-term bond, such as the 3-month note. This is unusual. Normally, longer-term bonds give investors a higher return in exchange for tying up their money for a longer period of time.

Inverted yield curves generally mean investors are anticipating a recession that will force the Fed to cut interest rates. Inverted curves often precede recessions. However, it can take 18 to 24 months for a recession to arrive after the yield curve inverts.

Over the past two weeks, the two-year bond yield has outperformed the 10-year yield, suggesting markets are expecting a recession soon. Many analysts say, however, that comparing the 3-month yield to the 10-year has a better track record of predicting recessions. These percentages are not reversed now.

Will the Fed keep raising interest rates even as the economy slows?

Flickering signs of the economy — slowing growth with strong hiring — have put the Fed in a difficult position. Chairman Jerome Powell aims for a “soft landing,” in which the economy weakens enough to slow hiring and wage growth without triggering a recession and return inflation to the Fed’s 2 percent target.

But Powell has acknowledged that such an outcome has become more difficult to achieve. Russia’s invasion of Ukraine and China’s COVID-19 lockdowns have driven up prices for energy foods and many manufactured components in the US

Powell has also indicated that if necessary, the Fed will continue to raise interest rates even amid a weak economy if that’s what it takes to tame inflation.

“Is there any danger of going too far?” Powell asked last month. “Certainly there is a risk, but I would not agree that this is the biggest risk to the economy. The biggest mistake we have to make…would be to fail to restore price stability.”

Copyright © 2022 by The Associated Press. All rights reserved.

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What does recession mean? GDP growth, unemployment, inflation all factor into how we define state of US economy Source link What does recession mean? GDP growth, unemployment, inflation all factor into how we define state of US economy

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