What is a recession and are we in one?

The National Bureau of Economic Research (NBER) is the group that determines when recessions begin and end.  But isn't a recession 2 or more consecutive quarters of declines in real GDP?  If so, why would we need a group to determine whether there's a recession?  Both the recession of 1980 and 2001 did not fit the commonly cited rule of thumb (i.e., real GDP did not decline for 2 consecutive quarter).  What does the NBER consider?  The three primary variables are real GDP, economy-wide employment, and real personal income (though they consider other variables as well).  According to a report released this morning (see table 5), real personal income less transfer payments (the measure used by the NBER) declined for the second consecutive month (down 0.1% in July and down 0.2% in August).  Payroll employment was flat in August while aggregate hours worked declined.  We won't get the first estimate for economic growth in the third quarter until the end of October, but most economists expect it to be small but positive, continuing the pattern of weak growth from the first half of 2011 during which the US economy grew at a 0.8% rate.  Add it up and it's a close call.  Since the declines in real income have only been for 2 months, payroll employment hasn't declined yet, and real GDP is still inching forward, it's still too soon to declare a recession.  Economists may debate whether we're on the verge of a recession, but for the average person, it still feels like one.

Recession forecast from Business Cycle Research Institute

Lakshman Achutan, COO of the Business Cycle Research Institute (BCRI) was on CNBC this morning and stated that the US economy is entering a recession.  He stated that it doesn't depend on further economic shocks from Europe and that it's not clear how deep the recession will be.  What's his track record?  The BCRI relies on a series of short-term, medium-term and long-term leading indicators of the economy.  They've correctly forecasted most of the recent recessions.  Recently, BCRI predicted that the current recession would end in the summer of 2009 (several months before it occurred) and dismissed the chance of a double-dip recession last year.  Both forecasts proved to be correct and show that they are not doomsday forecasters.  Here's a link to their report that discusses their recession forecast.

Some "good" news, some concerns

There were a few pieces of somewhat good economic news released today; "somewhat good" means they point to slow growth as opposed to a recession.  Unemployment claims declined by quite a bit, to below 400,000, but this would need to continue in upcoming weeks to confirm that it was not a fluke (seasonal and technical factors played some role in the decline according to the Labor Dept.).  The BLS released preliminary estimates of revisions to employment data which indicated that there were 192,000 more jobs than originally estimated as of March 2011, 140,000 of which were in the private sector (revisions will be made official in Feb 2012).  That would still leave the economy down 6.7 million jobs since the start of the recession, but every little bit helps!  Finally, new estimates indicate that the economy grew at a 1.3% in the second quarter, slightly more than previously estimated.  Inventories increased at a slower rate than previously estimated while consumption was stronger than earlier estimates.

One piece of data that I follow closely is the risk premium for investment-grade corporations (Baa corporate bonds).  It reached a post-Depression record in late 2008 of just over 6% before declining to about 2.5% following the end of the financial crisis.  As of yesterday, it was back up to 3.39%, the highest for any non-recessionary period other than immediately after 9/11.  That suggests that there is significant stress in financial markets, most likely due to the poor economic outlook and risk aversion resulting from the European debt crisis.

Rick Perry vs. Ben Bernanke

Though I don't want to dwell on politics much in this blog, sometimes it's a hard subject to avoid.  Rick Perry renewed his attack on Ben Bernanke yesterday, stating "We would put someone in who actually believes that the private sector is how you stimulate the economy -- not by printing more money at the Fed."  Does Ben Bernanke think that printing money is the key to economic growth?  Here's part of Bernanke's speech in Cleveland last night (note: this is not the first time that he made these points):

"In a nearly half-hour prepared speech, given as part of the Clinic's "Ideas for Tomorrow" series, Bernanke talked about lessons that can be learned from emerging market economies such as China and Korea. Some of the common threads of success stories include low inflation, deregulation, privatization, fiscal discipline and the reduction of tariffs and the removal of other controls on exports and imports."

Low inflation, deregulation, privatization, fiscal discipline and freer trade - those sound like policies that conservatives would embrace; policies that seem to rely on the private sector for economic growth.  Bernanke added:

"Monetary policy can do a lot but it's not a panacea. It can't solve all of the problems..."

I don't think Operation Twist will be that effective and QE2 had a limited impact, but clearly Ben Bernanke recognizes that the private sector is the key to sustained economic growth.  However, he doesn't have a say on fiscal discipline, trade policy, or regulations that affect non-financial businesses.  It's disingenuous to blame him for budget deficits and other economic policies that are beyond his control.

Latest income data for Florida

The Census Bureau released estimates for state/income data yesterday and, as expected, it paints a sad picture.  Median household income for Florida, adjusted for inflation, declined to $44,243 in 2010, a decline of 10.4% from its peak in 2006, reaching the lowest level sine 1997.  Preliminary results show that the percent of people living in poverty in Florida was 17% in 2010, above the national average of 15.1%.  Orlando saw its median household income decline to $38,098, a 17% decline from its peak in 2007, causing an increase in the poverty rate to 18%.  Given continued economic weakness in 2011, these numbers are likely to get worse before they get better.

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Operation Twist

As expected, the Fed announced that it's going to implement operation twist - selling $400 billion worth of short-term securities and buying $400 billion worth of longer-term securities.  In addition, the Fed plans to reinvest funds from mortgage-backed securities (MBS) into MBS rather than treasuries.  The goal is to reduce long-term interest rates in general and long-term mortgage rates in particular.  How much of a difference will it make?  Perhaps a little, but not too much.  Mortgage rates will probably decline somewhat, but that depends on other factors as well (whether new economic data indicates weakening of the economy, investors seeking safe-haven plays, etc.).  In addition, the Fed stated that there are significant downside risks to the economy, which is the primary reason it thought it needed to provide further stimulus.  The initial reaction of financial markets was a major decline in stocks and record-low yields on ten-year bonds.  In addition, the dollar strengthened against the yen, euro and pound.

Politics and the Fed

Research and practice indicate the it's best for central banks to be independent of the political process.  In fact, since the 1990s, central banks in most economies have become more independent.  Exceptions include Venezuela and Argentina - two countries now experiencing very high inflation.  Recently, the Fed has come under increasing criticism from politicians from both the left and the right.  While Presidents Reagan and Clinton honored Fed independence, the times seem to be changing.

Yesterday, the Republican leaders of Congress, in a move not seen in recent history, sent a letter to the Fed that urged it not to engage in any further stimulus.  It should be noted that they added that if further stimulus is implemented, it should make the case for the stimulus.  Of course anyone who follows the Fed knows that the Fed always makes the case for its policy by releasing a statement explaining its policy decision (you may disagree with its case, but it provides support for its decision).  Why would the Fed want to engage in stimulus?  It expects inflation to be close to its stated goal (close to 2%) while economic growth and unemployment are awful (do I think they should do more stimulus today?  Keep reading).

On the left, Rep. Barney Frank wants to keep Fed district presidents from being voting members since he thinks they tend to focus more on inflation than economic growth.  However, many Fed district presidents are the strongest proponents of more stimulus (president of Boston Fed, Chicago Fed, etc).

Though I may not agree with every decision that the Fed makes, members of the Fed are thoughtful and have a much better understanding of the economy and monetary policy than members of Congress and most politicians.  For example, a presidential candidate explained that he doesn't like Ben Bernanke because he thinks there's too much government spending.  Of course, Ben Bernanke is not involved in government spending.  There are many other examples in which politicians have displayed a lack of understanding of monetary policy (as well as other issues!).  Shouldn't elected officials have a say in what the Fed does?  The President and Congress set the guidelines for Fed policy and have given it two mandates - low inflation and low unemployment.  Congress can change that to a single mandate of low and stable inflation.  One of the early supporters of that approach was Ben Bernanke.  However, he recognized that, since other factors can have temporary effects on inflation and policy takes time to have an effect, low and stable inflation is an intermediate term goal (in other words, a change in Fed policy today would have a significant impact on inflation until 2012, so it need to consider the likely direction of inflation instead of the current rate).  Would a single mandate have kept the Fed from implementing QE2?  Ben Bernanke has emphasized that one of the primary motivations behind QE2 was to prevent deflation, so a single mandate linked to inflation wouldn't have made a difference.

Should the Fed implement more stimulus today?  If I was a voting of the Fed, I  would vote no (I also leaned against QE2).  Monetary policy is very stimulative already and most of the current economic problems today won't be solved by even looser policy.  The Fed may want to save their remaining ammunition in case of another crisis (which may result from sovereign defaults in Europe).  One last point - is inflation out of control and, as Newt Gingrich state in a recent debate, is Ben Bernanke engaging in a highly inflationary policy?  The facts thus far indicate that inflation has been lower under Ben Bernanke than almost any other Fed chair.  In addition, financial markets expect inflation to remain under 2% per year for the next decade (based on the TIPS market).  Also, while some economists have tried to make the case for higher inflation (more than 2%), Bernanke has rejected that approach and emphasized that the Fed still seeks a medium term goal of 2% inflation.  So Bernanke's goal is clearly not higher inflation.

Though I would have made different decisions than Ben Bernanke and the Fed, I think Bernanke is being unfairly maligned as politicians look for easy targets to blame for the state of the economy.

Changes Over the Last Decade

Here is an interesting link from real-time economics showing that only those with advanced degrees saw their incomes rise more quickly than inflation over the last decade (based on census data).

This story is from 9/11 AOL's Daily Finance) and considers how the economy has changed since 2001 including comments from different economists.

The IMF just came out with its latest global forecast.  Within the report is a chart that shows the change in jobs based on pay (lower third, middle third and top third from 1993-2006) for different countries.  All countries show the same trend: significant declines in the middle with most showing increases in the top and bottom.

Inflation and jobs

This morning's inflation report confirmed that inflation is firming, at least for now.  Though people don't like to hear this, when you exclude food and energy, inflation is lower than the headline figure, but core inflation is still 2%, the highest in recent years.  Unlike last year, there are no signs of potential deflation for the foreseeable future.  This should reduce the likelihood of Fed easing at it's next meeting next week.  By the way, why look at core inflation instead of overall inflation?  Gas prices have dropped since the data for the report was collected, which should lead to lower inflation next month.  Fruit and vegetable prices spiked in the 3 months ended in February, declined over the next 3 months and rose significantly again between May and August.  That led to higher inflation early in the year, less inflation in the Spring and more in the summer (even including seasonal adjustments).  Over time, headline inflation is the figure to watch, but it tends to be distorted in the short term by the volatility in the prices of certain products.
Meanwhile, new claims for unemployment rose, signaling continued weakness in the jobs market.  Given the weakness in the job market and higher inflation, real weekly earnings declined by 0.8% in August and is now down by 2.2% since it's recent peak in October 2010.  Clearly, weakness in the job market along with weak earnings will continue to put pressure on consumer spending, contributing to continued economic weakness into 2012.

Interview in Orlando Sentinel

I was interviewed for a blog post in the Orlando Sentinel.   As typically found on blogs, there were several negative comments.  For those who are interested, here is the complete text of what I said:

It’s hard to make the case that major reductions in government spending in the near term will result in more economic growth.  Most who advocate that approach also want the dollar to strengthen in value.  The few countries that are cited as reducing government spending and achieving short-term economic growth benefitted from a weaker country and increased exports to a strong global economy (for example, Canada in the early 1990s).  Given weakness in the global economy, it’s hard to see how a stronger dollar (and thus more expensive exports) combined with major, immediate reductions in government spending will lead to more economic growth in the near term.

Time to criticize the other side.  The first round of stimulus tended to focus on temporary increases in demand (cash for clunkers, short-term tax cuts to encourage spending, etc.).  Thus, when the stimulus ended, so did it’s effect.  Given that it was clear to many economists that this would be an extended recession/period of economic weakness given that it was due to a financial crisis, short-term increases in demand were ineffective (more government debt without much economic benefit).

What about the balance between encouraging growth and containing the national debt?  It’s a tricky balance.  The national debt is a major medium-term problem, but the record-low interest rates on government bonds indicates that global investors are not worried about the credit-worthiness of the US (at least for now).

Given the above, there is room for policies that encourage economic growth accompanied by concrete plans to reduce the deficit over time.  The policies should both encourage demand in the short term while enhancing long-term economic growth and the underlying strength of the US economy.

·         Tax reform, both corporate and individual, that eliminates most deductions/loopholes while reducing tax rates could increase revenue somewhat while encouraging economic growth.  Note: many conservative economists, such as the chair of Reagan’s council of economic advisors, Martin Feldstein, consider many of the loopholes to be a hidden form of spending and thus eliminating them would not be tax increases but eliminating tax expenditures (see WSJ article).

·         Spending on needed infrastructure improvements could lead to construction jobs while making the economy more efficient.  Rather than spreading the money across congressional districts, identifying the top priorities for the nation could be more efficient (electric grid, ports, etc.).  Dare I suggest a commission develop the priorities since most citizens lack faith in the government to choose the right priorities?

·         A temporary reduction in both the employee and employer portion of the payroll tax won’t have much long-term benefit, but could provide workers with extra after-tax income while also temporarily reducing the cost of employing workers.  The self-employed would particularly benefit as they pay both portions of the payroll tax.  Reducing both portions by 2% would result in a 4% reduction in tax rates for the self-employed and help some small businesses.

·         The primary reform for long-term deficit reduction would involve reforming entitlements, since they are the major reason for future increases in the national debt.  It gets complex, but reforms should include means testing of Medicare and making it more market-oriented; also adjusting increases in social security benefits by the inflation method preferred by economists for other purposes (it gets technical, but it’s called a chain-weighted index and has been around for quite a while; not a trick designed recently).  This would reduce the deficit by hundreds of billions of dollars over the next decade while using a more accurate measure of inflation.

Of course there are other things, but this is a start: encourage demand and economic efficiency while also getting the deficit under control over time.  This wouldn’t result in an economic boom, but provide both short-term and long-term help to the economy given the economic environment in which we’re operating.

This morning's job report

Clearly, this morning's report about the job market was not good.  Net job creation was zero, the weakest since September 2010; private sector job creation was the weakest since early 2010.  Of particular concern was the widespread decline in aggregate hours worked across many industries in the private sector.  Thus, even though the number was distorted by the strike by 45,000 Verizon workers, there was weakness throughout the economy.  Aggregate hours worked declined significantly during the month and is on track for a decline of about 0.4% for the third quarter (annualized rate), the first quarterly decline since late 2009.  Another concern for the future of the job market is the decline in productivity thus far in 2011, which suggests that companies face no pressure to add workers to meet current demand (i.e., rapid increases in productivity would suggest that workers are being stretched to meet demand; declining productivity implies workers aren't being pressed to produce at an optimal rate and thus new workers are not needed).  Another concern is that the number of people working part time for economic reasons surged by over 400,000, resulting in an increase in the U6 measure of unemployment to 16.2%.

How about some good news?  The private sector added 17,000 jobs.  If you add the 45,000 striking Verizon workers, that increases to 62,000, indicating weak growth as opposed to outright decline.  At best, it suggests that the job market will continue to struggle into 2012, with unemployment remaining at historically high levels.  In fact, the OMB forecasts that the unemployment rate will average 9% in 2012.