The hopeful economic narrative today is a developing global growth upturn. Unaware that international economic cycles can fall out of sync, many have blithely conflated upturns abroad with a simultaneous revival in U.S. economic growth.
But it’s across the pond that an actual cyclical recovery began this year. Beating consensus expectations, the latest Eurozone GDP validated our contrarian call last spring that a Eurozone growth upturn was at hand, but such cyclical upturns overseas don’t always translate to a revival in U.S. economic growth.
We know that international cycles can be out of sync because monitoring economic cycles across time and around the world is ECRI’s raison d'être. We’ve been determining recession start and end dates for the major economies for many decades – indeed, our entire existence – thanks to our history and heritage.
ECRI today houses the third generation of researchers building on the tradition of cyclical investigation established by its late co-founder, Geoffrey H. Moore, whom The Wall Street Journal called "the father of leading indicators." Moore represented the second generation that, following the first generation of business cycle researchers – his mentors, Wesley Mitchell and Arthur Burns – developed the first list of leading indicators of recession and recovery 70 years ago, and the original index of leading economic indicators more than half a century ago.
Decades earlier, Mitchell had laid the foundation for this work by defining just what a recession was, yet ignorance about recessions abounds. In the desire for simplicity, the notion that a recession is simply two successive quarterly declines in GDP, which measures the nation's output, has taken hold. But back-to-back quarterly declines in GDP are neither necessary nor sufficient for there to be a recession.
The idea originated in a 1974 New York Times article by Julius Shiskin – a onetime colleague of Moore’s – providing a laundry list of recession-spotting rules of thumb, including two down quarters of GDP. Over the years, all the other recession markers dropped away, leaving behind only "two down quarters of GDP." Like most rules of thumb, it's far from perfect. For example, it failed in the 2001 recession.
What is a Recession?
Mitchell’s longstanding definition of recession encompasses the key elements of a recessionary vicious cycle – output, employment, income and sales. While all government data are subject to revision, simultaneous reliance on all four of these aspects of the economy produces recession start and end dates that can stand the test of time, as ours have. But there’s an even deeper reason.
A recession is not a mere statistic, but rather a self-reinforcing downturn in economic activity. Under certain circumstances, a drop in spending can lead to cutbacks in production and thus jobs, triggering a loss of income, hurting sales and in turn feeding back into a further drop in production, all the while spreading like wildfire from industry to industry, and region to region.
A recession is a very specific sort of vicious cycle. That is why its proper definition cannot be limited to a single statistic like GDP, but must also include industrial production, jobs, income and spending, all spiraling down in concert.
To appreciate the toll of misdiagnosing recession, let’s recall the aftermath of the March-November 2001 recession, during which the real-time data – until July 2002 – showed just one down quarter of GDP, leading some policy makers to claim there had been no recession. Surely, that misperception influenced their policy response.
In end-July, revisions showed GDP falling for three straight quarters. And, with the benefit of hindsight, we now know that GDP actually zigzagged between negative and positive readings, never falling for two successive quarters. To most Americans, the far more important issue was the associated loss of 2.7 million jobs – more than in any prior postwar recession. Clearly, there are times when the economic reality is harsher than GDP might imply.
And fast-forwarding to 2008, right before the Lehman Brothers collapse, the GDP data didn’t show any quarterly drop in GDP since 2001, other than a miniscule dip in Q4 2007, followed by renewed positive GDP growth in the first two quarters of 2008 that persuaded many that a recession had been avoided, even though we now know that GDP growth fell deep into negative territory in Q1 2008. But it wasn’t until a month after the Great Recession ended that the revised GDP data showed that reality.
Again, this gross misperception in 2008 led policymakers astray. Nearly half a year inside that recession, we argued publicly that, while GDP releases had yet to show a decline, the economy was on a recession track. So unorthodox was our view that, a month later, in June 2008 – with the economy deep inside the recession – the Fed encouraged the markets to bet on over 100 basis points of Fed rate hikes by year-end!
These examples illustrate the danger of being misled by a flawed rule of thumb, or imagine that it makes no difference to policy or investment decisions. But determining when a recession began and ended, even with 20-20 hindsight, is no easy task. As it happens, this is a job which ECRI has long done for our own benefit and as a public service.
Dating International Cycles
Any endeavor that can be impacted by a determination of recession, be it macroeconomic research or business contingency plans, requires authoritative benchmark dates for when recessions started and ended. The international business cycle chronologies maintained by ECRI are regarded around the world as the gold standard.
A recent paper from the Bank for International Settlements (BIS) – the central bank for central banks – notes: “To define recession dates, we follow the most widely used procedure. We take the recession dates from the National Bureau of Economic Research [for the U.S.] or the Economic Cycle Research Institute [for other countries]. These rely on expert judgment based on the behavior of several variables, such as output and employment.”
The validity of the conclusions of that BIS study and many others is critically contingent on the reliability of the ECRI recession dates. Determining those dates requires the sort of “expert judgment” that even the highly qualified BIS economists don’t presume to possess.
Growth Rate Cycles
While business cycles consist of alternating periods of economic expansion and contraction, growth rate cycles (GRCs) –also called acceleration cycles – are alternating periods of acceleration and deceleration in economic growth. They are tantamount to a sort of first derivative of business cycles, and are just as important, if not more so, for investors.
In fact, before the financial crisis, there was a close correspondence between cyclical downturns in stock prices and GRC downturns, only some of which became recessions. Following QE and other unconventional monetary policies, that hasn’t been the case, but the major stock price corrections seen over the past decade are clustered around GRC downturns, which also typically see declines in corporate earnings.
Suffice it to say that historical GRC dates – like historical recession dates for 22 economies, available freely from ECRI – can be valuable for investment strategies. These chronologies also shed light on the synchronization of international cycles.
Cycles Not Always Synchronized
Many don’t realize that international economic cycles aren’t always synchronized. In recent years, for example, U.S. economic growth kept accelerating until around mid-2018, thanks to post-hurricane rebuilding and then tax cuts, long after Eurozone growth had started to slow.
But, by the middle of last year, Eurozone economic growth – entering a fresh GRC upturn – started picking up, while the U.S. stayed in a GRC downturn. Under the mistaken belief that a Eurozone recovery must coincide with a U.S. revival, many investors jumped to the conclusion that the U.S. slowdown had ended.
That’s certainly not the case. Indeed, international GRCs haven’t necessarily been historically synchronized. ECRI’s international business cycle chronologies reveal an extended period of asynchronous recessions in the 1990s.This sustained the global slack that permitted robust U.S. economic growth without boosting inflation pressures and forcing the Fed to hike rates.
A Common Denominator
As we see, understanding the historical chronology of international cycle dates can be uniquely revealing. Fed Chairman Jerome Powell has explicitly invoked Fed policy in the 1990s as a model for what the Fed will do next. But only by knowing the cyclical facts can one appreciate the true lay of the land.
As David Foster Wallace tells it, two young fish happen to meet an older fish swimming the other way, who nods at them and says, "Morning, boys, how's the water?" The two young fish swim on for a bit, and then eventually one of them looks over at the other and goes, "What the hell is water?"
In a world dominated by market economies, cycles are an inherent part of the uncertainty that challenges decision makers. In this respect, ECRI is an older fish chronicling the facts around where we are in the long – and broad – a history of economic cycles.
Stay tuned for what comes next.