The Business Cycle Basics of this Recession

Understanding the depth, diffusion and duration of this downturn.

Business Cycle Basics

This is a brutal recession, but may not be as bad in one respect. To understand why, we must assess the severity of this recession in terms of the Three D’s: depth, diffusion and duration. 

With over 21 million jobs already lost in just two months, compared with fewer than nine million jobs lost over two years during the Great Recession, this recession is already off the charts in terms of depth. And the widespread economic weakness seen across industries and regions testifies to its likely severity in terms of diffusion.

Source: ECRI
Source: ECRI.

Duration Could Be Short

But on the third “D” – duration – this recession could end up being among the shortest on record. While hard to believe, this is because – after economic activity has plunged so deeply – even a slow, partial opening up of the economy could begin to lift economic activity off those extreme lows. With that gradual reopening likely to begin soon, the recession could plausibly end by summertime, in which case it would have lasted just half a year or so, compared with a year and a half for the Great Recession. 

But let’s be clear. Just because the recession is relatively brief doesn't mean we’d be back to normal in short order. Many businesses would have closed for good and – with so many jobs disappearing – the unemployment rate would still stay painfully high for years. 

ECRI was practically alone in predicting back in April ’09 – when all the talk was about depression – that the Great Recession would end by summer and, sure enough, it ended in June ’09. But the fact that the recession technically ended didn't mean all was okay – it took many years to get back to anywhere near pre-recession levels of employment and economic activity. It is likely to be at least as hard this time. 

Source: ECRI
Source: ECRI.

This is because a recession isn’t just “bad times.” As the stylized chart shows, it’s specifically the period when economic activity is declining, i.e., the economy is contracting. 

The recovery begins as soon as economic activity starts increasing, however far it might still be below pre-recession highs. Of course, if it’s a shallow or halting recovery, it could take a long time to get back to pre-recessionary conditions. 

In fact, it could easily take years for the economy to get back to “normal.” And the new version of normality may be quite different from the old one in many respects. Regardless, a recovery is all about a sustained increase in aggregate economic activity, and is not negated by such details. 

Source: ECRI
Source: ECRI.

What Recovery Looks Like

Remember, a recession is really a vicious cycle, with cascading declines in output, employment, income and sales, which feeds back into a further drop in output, spreading like wildfire from industry to industry, and region to region. This domino effect is key to the diffusion of recessionary weakness across the economy.

Source: ECRI
Source: ECRI.

A business cycle recovery really begins when that recessionary vicious cycle flips and becomes a virtuous cycle, with rising output triggering job gains, rising incomes and increasing sales, which feeds back into a further rise in output. The recovery can persist only if it becomes self-feeding. 

The key is knowing when that will happen, and this is where good leading indexes are critical, because – while this was a mandated recession – the recovery will be dominated by cyclical forces. And that’s because you can force a recession, but you can't force a recovery.

Source: ECRI
Source: ECRI.

We understand why every analyst is focused on the epidemiology, on when effective therapeutics and vaccines will become widely available, and on when states will allow schools and businesses to open up again. But the beginning and end of this recession aren’t symmetric. Sure, you can mandate a recession, but you can’t mandate a recovery. It’s not like flipping a switch. 

Imagine you drove home, switched off the engine and left your car in the driveway through a bitterly cold winter month, because you got really ill and couldn’t get out of the house. Now your classic car has an iced-up carburetor, some water in the fuel lines may have frozen solid, the engine oil has turned to molasses, and the old battery is practically dead, too weak to turn the engine over. It’s not that you’ll never drive that car again, but it won’t start right away. 

Follow the Leading Indexes

This is where good leading indexes come in. They’ll tell you when the car is actually ready to start, so to speak – when things will be ready to start turning. 

And by leading indexes I don’t mean econometric models back-fitted to recent decades’ data that don’t include anything like the current crisis. Instead, it makes sense to rely on conceptually-rooted leading indicator systems that have been tried and tested in many market economies, including the U.S. over more than a century of recessions, spanning the 1918-19 recession during the Spanish flu, as well as the Panic of 1907, when the Fed didn’t exist. 

We depend on such robust leading indexes to signal whether this recession – which could plausibly be quite brief – will actually start to recover in a sustainable fashion. So far, they haven’t made that end-of-recession forecast. But there’s now a hint of light at the end of this tunnel, with ECRI’s Weekly Leading Index having risen 11% in the last five weeks after plunging 30% in the previous nine weeks. In the coming weeks and months, such high-frequency leading indicators will be especially worth watching. 

ECRI's Anirvan Banerji contributed to this article.

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