Tuesday, February 19, 2008

What is a recession?

There are two definitions for a recession. One is formal and set by the NBER and the other is an informal approach. The informal definition states that a recession is two consecutive quarters of negative GDP growth. The more formal approach is based on watching four economic series as well as the GDP series.

The NBER committee places particular emphasis on two monthly measures of activity across the entire economy: (1) personal income less transfer payments, in real terms and (2) employment. In addition, the committee refers to two indicators with coverage primarily of manufacturing and goods: (3) industrial production and (4) the volume of sales of the manufacturing and wholesale-retail sectors adjusted for price changes.

Personnel income peaked in September of last year without counting transfer payments. On a real basis personnel income is still above 3% assuming an inflation rate of 2.5%. Transfer payments have changed by 1.25 percent over the last year so personnel income would still be positive albeit below the long-term growth trend of 3%.

The unemployment rate has moved up from the lows of 4.5 percent at the beginning of 2007 to the current levels of 4.9 percent. This change is not near the levels for the last recession but is clearly trending up.

Industrial production is above its lows but only reaching 2% on a nominal basis.

Retail sales have hovered around 4% on a nominal basis so sales are below the long-term trend on a real basis.

Looking at either the formal or informal numbers tells us that we are still not at the point of being in a recession; however, the markets seem to focus on the probability estimates for a recession and that is telling s slightly different story. Using the probability models, the chance of a recession on a forward basis is in some cases over 50%.

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