Originally published in The Boston Globe
Tuesday, May 22, 2001

Looking for Signs of Recession?
By Martin and Kathleen Feldstein

"On the basis of the most recent statistics, the US economy cannot be classified as in recession. There are, however, worrying signs."

"Is the American economy in recession? And if not now, will it be?" Those are the questions that we are asked most frequently these days. With share prices down sharply over the last year and with frequent announcements of substantial profit declines and major employee layoffs, it's not surprising that the R word is on the minds of so many people. That concern about recession has driven consumer confidence down sharply even though national output or GDP actually rose (at a rate of two percent) in the first quarter of this year.

If there is a recession in 2001 it will be the seventh recession in the past 40 years. Each recession has brought with it a painful rise in unemployment and a decline in personal incomes. Fortunately, though, the average recession has lasted only eleven months from the peak of activity when the recession began to the eventual trough when the recession ended and the economy turned up. Even the longest of the downturns only lasted 16 months while the shortest was over in just six months.

There's no doubt that the manufacturing sector of the US economy is now in recession. Output in manufacturing peaked last September and has been declining ever since then. Manufacturing employment and the sales of manufactured products are also down.

But manufacturing is only part of the American economy and the rest of the economy is showing more robust activity. The economy is classified as in recession only if there is a widespread downturn in economic activity that brings with it an overall decline in employment, production, personal incomes, and total manufacturing and trade sales. That downturn must be deep enough or long enough to be classified as "significant and substantial." (Although a recession is usually accompanied by a decline in GDP, the popular press definition of "two quarters of declining GDP" is not the official standard.)

On the basis of the most recent statistics on economic activity, the American economy cannot be classified as currently in recession. There are, however, worrying signs, and if there is continued deterioration, economists will eventually conclude that the economy is now in a recession that began in February or March. More specifically, three of the four basic measures used to decide whether a recession has begun have already started to slip. Industrial production, manufacturing and trade sales and overall employment have turned down, with only personal incomes still continuing to rise. If these downturns continue and fall far enough or for long enough, the Business Cycle Dating Committee of the National Bureau of Economic Research, the official arbiter of when recessions begin and end, will conclude that there has indeed been a recession in 2001. But it is still too soon to jump to that conclusion now.

The Federal Reserve obviously thinks there is enough risk of a recession to warrant the sharp reduction in the short term interest rate that it has engineered during the past four months. And although lower interest rates cannot raise a defunct dotcom company from the dead or stimulate new equipment investment in a manufacturing firm that is experiencing collapsing sales and has substantial excess capacity, lower interest rates can stimulate more activity in some parts of the economy which can eventually spread to all sectors of the economy.

The lower short term interest rates set by the Federal Reserve have brought down mortgages rates, lifting the sales of new and old homes to record levels. That not only stimulates more home building but also leads to more sales of furniture and other consumer durables. Lower interest rates also reduce the monthly payments on existing adjustable rate mortgages, leaving households with more money to spend on everything from clothing to pizzas. Eventually that extra spending will increase operating rates and profits of a wide range of businesses. And that in turn will lead to more investment in new plant and equipment. The rising sales and resulting profits should also increase share values, further encouraging additional consumer spending.

The tax cut that is virtually certain this year should also be a stimulus to consumer spending. Even if the tax rate cuts provide little extra spendable cash in the first year after the legislation is enacted, the knowledge that tax rates and liabilities will be coming down over the next several years should also stimulate increased willingness to spend now.

We're not ready to say whether an expansion will begin soon enough to avoid a recession. The biggest risk to a favorable upturn continues to be the possibility of a major fall in consumer spending. At the present time, consumers are still spending at an unprecedented rate. For the economy as a whole, total spending outlays now exceed total afer tax income, implying a negative overall saving rate. If that negative saving rate declines suddenly as consumers decide to tighten their belts in anticipation of harder times ahead, a mild downturn could become a major recession.

While a negative saving rate cannot continue indefinitely, it can continue for a long time as retirees spend accumulated portfolio wealth and those near retirement age do little saving because they already see their assets exceeding the amounts that they need to retain their current incomes in retirement. It could take years before the next age group will be ready to start saving in order to accumulate reserve assets.

So we continue to regard a recession of 2001 as a possibility, but definitely not a sure thing. It is even possible that unemployment will rise further at the same time as the overall economy continues to grow - creating a so-called growth recession. But barring that and the separate possibility that inflation might yet become an issue for the monetary authorities, the current record expansion could just continue for years to come.