If it Isn't a Recession, What is IT?
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If it Isn’t a Recession, What is IT?
Edward E. Leamer
August 30, 2001
There is a difference between the symptoms and the disease.
A symptom of a bear market is a drop in equity values of 20% or more. A
symptom of a recession is back-to-back quarters with negative growth. But
these are not diseases; these are symptoms.
Journalists and many economists seem not to recognize the difference. When
equity prices have fallen by 19%, MSNBC switches to round-the-clock
coverage in the event that the one extra percent fall will turn it into a BEAR MARKET. (caps signifying
scary stuff here). When the preliminary estimate of GDP growth in the second quarter was only 0.7%, the
press proclaimed NO RECESSION YET and went on heightened alert for
any early warning signs that after revision the number might turn
negative. We breathed a huge collective sigh of relief when the revision
announced on August 29 squeaked past the zero mark and scored a 0.2%,
and almost every newspaper in the US carried this as front page news.
This is silly and off the point.
A recession is a market failure that produces substantial, sustained and
unwanted idleness of capital and labor.i The two adjectives “substantial”
and “sustained” are what make a recession announcement newsworthy.
If we could confirm that the second quarter of 2001 is the beginning of a
recession, this would mean that the rest of 2001 and some of 2002 are likely to be more than moderately
difficult for labor and capital.ii It means that you and I need to adjust our financial portfolios. It means
that businesses need to adjust their portfolios of people and capital.
The unwanted idleness of labor and capital means slower growth, of course, and maybe even two negative
quarters. But there is enough randomness in the GDP data that the economy can be suffering from the
pathology of a recession and not have the two negative quarters. Moreover, there is no momentum in the
GDP growth numbers that would help to forecast the future. There is no tendency for a good quarter to be
followed by another good quarter, or a bad quarter to be followed by another bad one. Thus the possible
GDP growth numbers for the second quarter of 2001, 0.7%, 0.2% and –0.5% , are all the same. It doesn’t
matter which one the Department of Commerce chooses.
The National Bureau of Economic Research is the Recession Umpire
To help us all deal with the anxiety that this ambiguity produces, we leave it to Business Cycle Dating
Committee of the National Bureau of Economic Research to tell us whether we are in a recession or not.
Unfortunately for forecasting, they do not offer their wisdom until long after the event. Here is the latest
word from the website of the NBER priests http://www.nber.org/cycles/recessions.html
Definition A recession is a significant decline in activity spread across the economy, lasting more
than a few months, visible in industrial production, employment, real income, and wholesale-retail
trade.
Q: The financial press often states the definition of a recession as two consecutive quarters of
decline in real GDP. How does that relate to the NBER's recession dating procedure?
1A: Most of the recessions identified by our procedures do consist of two or more quarters of
declining real GDP, but not all of them. But our procedure differs in a number of ways. First, we
use monthly indicators to arrive at a monthly chronology. Second, we use indicators subject to
much less frequent revision. Third, we consider the depth of the decline in economic activity.
Pronouncement: "The data continue to suggest that the only substantial declines in real activity in
the U.S. economy are in manufacturing. Broader aggregates, such as employment and real
personal income, have not fallen significantly or at all."
.
Even the NBER seems to
define a recession in terms of Figure 1
its symptoms, though with
Capacity Utilization in Manufacturing
much greater ambiguity than
two consecutive negative 95
quarters. While it is difficult
to decode the NBER’s 90
words, it isn’t hard to
Per cent Utilization
85
interpret their decisions.
Show your 10-year old
80
daughter Figure 1 and ask
her to find the deep valleys 75
between the mountains, ones
that are closest to sea level 70
and surrounded by steep
mountains. This is a chart of 65
capacity utilization in 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998
manufacturing. Low capacity
utilization means idleness of
capital. Ask her also if we Figure 2
are heading into another
valley. She will say yes Capacity Utilization in Manufacturing and NBER Recession Dates
NBER Peak to Trough Periods in Yellow
Compare your
95
daughter’s answers with the
answers of the NBER
90
priests displayed in Figure
2 which has the NBER
Per cent Utilization
85
recessions (peak quarter to
trough quarter) in yellow. 80
While we have her attention, 75
ask your daughter to
identify the steep westerly 70
facing slopes of the
mountain range in Figure 3 65
which depicts the 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998
unemployment rate –
idleness of labor - with the
NBER recessions in yellow. I think she will pick out all the NBER recessions, and only those recessions.
And ask her if we are currently climbing up one of those steep mountain faces. It isn’t quite so clear in this
mountain range, but it sure looks ominous.
2Figure 3
Unemployment Rate and NBER Recession Dates
NBER Peak to Trough Periods in Yellow
12
10
Per cent Unemployed
8
6
4
2
0
1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998
One last task: have her look also at Figure 4 which is the growth rate of real GDP. Ask her to identify the
periods when the bars tend to dangle down instead of standing straight up. She will probably be able to
reproduce the NBER dates pretty well, but this is a bit harder task, with more ambiguity. And the evidence
that we are in recession just isn’t there yet.
Figure 4
Growth Rate of Real GDP and NBER Recession Dates
NBER Peak to Trough Periods in Yellow
20
15
Rate of Growth of Real GDP
10
5
0
-5
-10
-15
1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998
3I hope you are getting my two points.
1. Idleness of people and capital is both the definition and a decisive symptom of a recession. Slow or
negative growth is not the definition nor is it an accurate symptom.
2. We are probably at the beginning of a recession that will bring increases in idleness of capital and
labor. There has never been this kind of decline in capacity utilization in manufacturing that hasn’t
been labeled a recession by the NBER. The rise in unemployment isn’t decisive yet, but it is getting
very close.
The GDP growth numbers do inform us about the severity of the downturn
You can see why the growth numbers aren’t helpful for determining if we are in recession by contrasting
capacity utilization in Figure 2 and the unemployment rate in Figure 3 with the growth numbers in Figure
4. Once you have capacity utilization and unemployment, there is no extra information in the GDP growth
numbers that could help make the recession call.
Although the GDP growth numbers don’t help tell us if we are in recession, they are very important for
another reason. If you look again at Figure 4 you will notice that the bars get more stable after 1985.
Furthermore, the recession in 1990 was very mild, reducing GDP by only -1.3% compared with –2.9% in
the 1981-82 recession, which had just been preceded by –2.2% reduction in the 1980 recession. Thus the
big question: Will this recession be brief and mild, or are we reverting to the volatility characteristic of the
economy before 1985?
There are several reasons to expect the recession to be brief and mild:
1. The stable components of GDP form a larger share of GDP than they used to. The share in GDP of
consumer services plus government which hovered around 50% in the 1970s is now at 58%.
2. Inventory management systems have mostly eliminated the “inventory correction” aspect of the cycle.
3. A significant share of the manufacturing cycle risk has been sloughed off to supplier countries in Asia
and Mexico.
4. Housing is not likely to contribute much to this slowdown because it hasn’t had the kind of boom in
the 1990s characteristic of earlier expansions and thus will not have the same kind of bust.
There is one reason for concern.
1. Business investment in equipment and software exploded in the 1990s and is in free-fall right now.
Figure 5 depicts the ratio of business investment in equipment and software divided by GDP. The
increase in this ratio during the economic expansions means that investment is one of the primary
locomotives that pulls the economy forward. When this locomotive sits on the sidelines, we have an
economic contraction.
4Figure 5
Investment in Equipment and Software / GDP
NBER Peak to Trough Periods in Yellow
11%
10%
9%
Share of GDP
8%
7%
6%
5%
4%
1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998
This figure tells us why GDP stabilized after 1985. It’s investment, stupid. Prior to the 1980s, the US
business expansions were pulled forward by the locomotive of investment, and the expansions terminated
when investment stalled. In the figure, the share of investment in GDP rose during the expansions and fell
during the recessions. The Reagan expansion was different. In the first two recovery years of the Reagan
expansion, investment pulled the economy forward, but from 1985 through the 1990/91 recession until
1992, business investment was sitting on the sidelines with a slowly declining share of GDP. This was a
mature economy with a lack of investment opportunities. Maturity meant steady but slow growth
averaging 2.7 ± 2.3 compared with 3.7± 4.9 prior to 1985. No boom and no bust. The recession of
1990/91 hardly registered.
The investment renaissance of the 1990s was very prolonged and very steady. This brought with it high
and stable growth rates: 3.7±2.0. It was the remarkable steadiness of the period that probably seduced
many analysts into thinking that this was a New Era. Because this was a period of slow growth of
employment, the productivity numbers were all the more remarkable. Productivity growth during the
Internet Rush from 1995 to 2000 was double what it had been during the maturity period from 1985 to
1992. The Congressional Budge Office and even Alan Greenspan came to think that this new growth in
productivity would be with us indefinitely, propelling us into the Nirvana Age of the New Economy. But
now we are just beginning the Comeuppance, during which we are beginning to discover that the old rules
apply to the New Economy. No profits, no investment, no growth.
5US Growth Since 1948
Annualized Rate
GDP Growth Employment Growth Productivity Growth
Mean Stnd. Mean Stnd. Dev. Mean Stnd. Dev.
Dev.
Post-War Boom 1948:1 - 1985:2 3.7 4.9 1.7 2.5 2.0 4.1
Maturity 1985:3 - 1992:2 2.7 2.3 1.5 1.6 1.2 1.5
Renaissance 1992:2 - 2000:3 3.7 2.0 1.6 0.9 2.1 2.0
Internet Rush 1995:1 - 2000:3 3.8 2.0 1.4 0.9 2.4 1.8
Comeuppance 2000:3 - 2001:2 1.3 0.6 0.1 2.0 1.2 1.5
Productivity is here measured by GDP per worker, not per hour.
To help understand what the Comeuppance might entail, we can look back in history to see if there are
similar periods. But the rise in this investment share in the 1990s is unprecedented both in terms of
duration and amount, and it is therefore impossible to find exact historic analogues. But the 1970s had two
relatively brief episodes with rapidly rising investment share of GDP. These were followed by severe
contractions that reduced real GDP by -3.4% in 1973-75, and by the double-dip decline in the early 1980s
that reduced GDP by –5.1%.
If you want to feel optimistic, you might refer to the Kennedy/Johnson expansion in the 1960s which had
an investment boom through 1966 but which managed to continue for three more years even in the face of
an investment slowdown. But it wasn’t monetary policy that kept that expansion going – it was fiscal
policy. It was the enormous increase in expenditures for the Vietnam war. You don’t want that again, do
you?
The bottom line: the closest historical analogues are the recession of 1973-75 and the double dip recessions
of 1980 and 1981-82.
What are recessions like?
IF this is like earlier recessions, it will have a typical pattern. Figure 6 illustrates the behavior of real GDP
over the eight recessions since 1948. The horizontal axis is the number of quarters since the NBER date
for the cycle peak. The data begin four quarters before this peak period and extend until the level of
employment recovers to its value at the peak period. The real GDP data have been normalized to equal
one at the peak which makes it impossible to compare the level of GDP one recession with another, but this
display is a very clear picture of the typical behavior of GDP over the cycle. In this figure I have also
plotted the most recent data as if the first quarter of 2001 were an NBER peak date, which is a strong
possibility. This is the dark line. The figure suggests that we have a couple of zero or negative quarters
ahead of us, but then a recovery early in 2002.
Figure 7 is the same kind of display for civilian employment and Figure 8 for the unemployment rate.
This last figure has an extended range to allow unemployment to drop to its level at the onset of the
recession or to bottom out at a new plateau.
The properties of these recessions are reported numerically in Table 1, which is headed by the NBER cycle
dates. The first panel has the real GDP data, then employment and last the unemployment rate. The last
column reports the averages of these data.
6According to the data in Table 1 the decline of real GDP has ranged from –3.7% in the deepest recession in
1957 to –0.1% in the very mild downturn that ended the Kennedy/Johnson expansion. The average is –
2.1%. It has taken 2.9 quarters to get that level of GDP and it has taken another 2.6 quarters for GDP to
recover to its level at the onset of the cycle.
The reduction in employment during these recessions has been less than the GDP reduction and also taken
more time. The average reduction in employment has been –1.3% compared with the GDP number of –
2.1%. It has taken on average 4 quarters to get to the bottom of the employment cycle and a total of 7
quarters to complete the cycle, compared with 2.9 quarters and 5.4 quarters for GDP.
Now that we are in the mood, we can take a look at some more figures like these in an attempt to discover
the profile of these recessions. There are many things that we might look at, but some of the more
interesting ones are hours, profits, interest rates and the stock market.
Figure 9 shows how hours in manufacturing move over the cycle, and Figure 10 has the same data without
the normalization. Figure 11 is corporate profits; Figure 12 is the ratio of profits to investment; Figure 13
the 3-month Treasury Bill Rate; and Figure 14 has the S and P 500 Index. From these I draw the following
conclusions
Hours A decline in weekly hours in manufacturing is an excellent leading indicator of a
recession. The decline that we have already experienced has been very significant. The
unnormalized graph shows that this decline has been from a very high level of hours of
almost 42 hours per week. This was a symptom of the high pace of the Internet Rush
period. It seems likely that things will slow down a lot more, literally.
Profits Profits tend to decline by about 20% during a recession but not before recession. We
have already had an alarming 33% decline.
Profits/Invest The race downward by profits and business investment was being won in 2000 by profits
but the good news is that in the last quarter (2001 Q2) they were neck and neck. The
ratio of profits to investment is a useful leading indicator of a recession, and the
stabilization of this ratio is about the only good news last quarter. But I have chosen to
display this figure in its unnormalized form to alert you to the dismal state of profits. The
shift from the Internet Rush pursuit of market share measured by clicks to today’s bottom
line measured in dollars is likely to have a chilling effect on investment for some
considerable number of quarters unless someone can figure how to squeeze some profits
out of all that IT equipment.
Interest Rates The short term interest rates tend to fall a quarter or two after the recession has
commenced, at which time the Fed gets the message and gives an injection of liquidity.
The Fed was ahead of the game during the 1990/91 recession with early, though not
substantial rate cuts. The Fed with its early and rapid rate cuts, and with its current
slower rate cutting is paralleling the 1960/61 rate cuts during a very mild recession.
Would that we will have it so good.
S and P Last for the good news for all you investors. The S and P bottoms out in the second or
third quarter of a recession and provides good returns thereafter. But watch out for a
repeat of 1973/75 and indeed the long bear market that lasted until the early 1980s.
7Consumers are not holding the economy above water. It’s state and local
governments
While I am nominating news articles for the “most misleading” category, I have to mention my number two
choice: The claim that consumers are holding up the economy. For example,
Economist.com, August 30, 2001:
The economy was saved from contracting only by a sharp upward revision of consumer spending,
as Americans shopped even though the rest of the economy is sluggish.
The facts are otherwise. Take a look at Table 2 which has the most recent GDP data. The first two
columns report the average real annual changes of the GDP components over the years ending in 1999 Q3
and 2000 Q3. These should be compared with the next three columns that indicate the changes during
each of the three quarters since the slowdown commenced. GDP, for example, was expanding at the
annual rate of $85.8 billion in the year ending in 1999 Q3 and by $97.2b in the year ending in 2000 Q3.
But starting in 2000 Q4 the GDP increases have dramatically declined each quarter: $43.8b in 2000 Q4,
$30.6b in 2001 Q1 and only $3.9b in the latest quarter, 2001 Q2.
The last three columns of Table 2 report the “difference in differences” namely the GDP change in the
selected quarter minus the change that occurred during the last year of the Internet Rush ending 2000 Q3.
Thus compared with the Internet Rush, GDP was growing more slowly in the second quarter by $93.3
billion. It was $97.2b during the Internet Rush but in 2001 Q2 was only $3.9b; that’s a turnaround of -
$93.3b. To put it another way, we lost 93/97 = 97% of our growth. What remains is not much bigger that
the “errors and omissions.” In other words, THE INTERNET RUSH IS OVER.
A closer look at the details in the last three columns of Table 2 helps to diagnose the disease. The rows
are ordered by the numbers in the last column, the column that compares 2001 Q2 with the last year of the
Internet Rush. The biggest change has been in equipment and software. Compared with the Internet
Rush, investment in equipment and software is off $69.3 billion. Next is consumer nondurables. All the
hype about the consumer keeping the economy afloat ignores the fact that the growth in consumer
nondurable expenditure is off $22.0 billion and the growth in consumer durables is off $3.2 billion and
services are off $8.6 billion.
There are only four items that are doing better now than during the Internet Rush. The largest positive
difference-in-difference is in net exports. This is a symptom of global production. Much of the decline in
expenditures by consumer and businesses is targeted at foreign suppliers which means lower imports and
an improved balance of trade. But as the supplier countries absorb the consequences of the US downturn,
they will grow more slowly as well, and we are experiencing a decline in exports and can expect futher
reductions in the future. In other words, don’t count on this as a source of growth.
The next largest difference-in-difference is expenditures by State and Local Government. But for the
$18.8b increase in state and local government expenditure, the second quarter GDP growth number would
have come in negative. Does anyone really think that whether we are in recession or not depends on the
size of this expenditure by state and local government? Yes, is the answer, if you define the disease by its
symptom. No is the correct answer.
Looking now to the 2000 Q4 and 2001 Q1 “difference in difference” column we see how the recession is
unfolding. In 2000 Q4, it was both businesses and consumers. There were declines in equipment and
software and consumer durables, and a sharp dropoff in consumer nondurables, from a $23.9b contribution
to GDP growth to $2.7b. In the next quarter, 2001 Q1, the story was dominated by disinvestment in
inventories. Businesses, troubled by the weak results at the end of last year and expecting sales to slow
further during 2001, chose to reduce inventories by almost $70 billion dollars, some of this accomplished
8by promotions and some by write-offs. The data for 2000 Q2 suggest that this inventory adjustment is
behind us. Now it is a full fledged meltdown of business investment on equipment and software.
Performance
Before I unwrap this quarter’s forecast numbers, I want to brag a bit. Figure 15 is a picture worth
considerably more than a thousand words. This compares our GDP growth forecasts issued in December of
last year with the Blue Chip forecasts and with the actuals. The Blue Chip consensus is totally useless,
since they just tell us that the future is about like the past. Historically, the US economy has had about a
3% rate of growth, so that is the consensus forecast.
Even if you pick only the bottom ten of the Blue Chip forecasters, the one that had the most pessimistic
view, their record is still really pretty dismal. No one out there was warning you that this recession was
coming. We were.
Forecast
If you have read this far, you already know that I do not expect investment in equipment and software to
turn around abruptly and create the kind of bounce back that the blue chip forecasters are still expecting.
We are going to have a full-fledged recession of the type displayed in the recession Figures 6 to 14.
Formal econometric analysis of the historical recession data and the recovery data yield the forecasts
reported in Table 3 and displayed in Figure 16. This recession forecast has a couple of negative quarters
to round out this year, and a recovery begins in the first quarter of next year and is in full swing by
midyear. With this will come rising unemployment. A slight rise in inflation makes the Fed wary of
further rate cuts and the 3-month Treasury rate drifts a bit lower, but not dramatically so.
9Recession Figures
Figure 6
Real GDP over NBER Recessions
1.08
1.06
48 Q4
1.04 53 Q2
57 Q3
1.02 60 Q2
69 Q4
1
73 Q4
0.98 80 Q1
81 Q3
0.96 90 Q3
01 Q1
0.94
0.92
-4 -2 0 2 4 6 8
Quarters before and after NBER Peak
Figure 7
Civilian Employment over NBER Recessions
1.02
1.01 48 Q4
53 Q2
1 57 Q3
60 Q2
69 Q4
0.99
73 Q4
80 Q1
0.98
81 Q3
90 Q3
0.97 01 Q1
0.96
-4 -2 0 2 4 6 8
Quarters before and after NBER Peak
10Figure 8
Unemployment Rate Over NBER Cycles : Long View
2.5
2.3
2.1 48 Q4
53 Q2
1.9 57 Q3
1.7 60 Q2
69 Q4
1.5
73 Q4
1.3 80 Q1
1.1 81 Q3
90 Q3
0.9 01 Q1
0.7
0.5
-4 1 6 11 16 21
Quarters before and after NBER Peak
Figure 9
Weekly Hours in Manufacturing During NBER Recessions
1.03
1.02
48 Q4
1.01 53 Q2
1 57 Q3
60 Q2
0.99 69 Q4
0.98 73 Q4
80 Q1
0.97
81 Q3
0.96 90 Q3
01 Q1
0.95
0.94
-4 -2 0 2 4 6 8
Quarters before and after NBER Peak
11Figure 10
Weekly Hours in Manufacturing During Recessions
42
41.5 48 Q4
53 Q2
41 57 Q3
60 Q2
40.5
69 Q4
73 Q4
40
80 Q1
39.5 81 Q3
90 Q3
39 01 Q1
38.5
-4 -2 0 2 4 6 8
Quarters Before and After NBER Peak
Figure 11
Profits During NBER Recessions
1.3
1.2 48 Q4
53 Q2
1.1 57 Q3
60 Q2
69 Q4
1
73 Q4
80 Q1
0.9
81 Q3
90 Q3
0.8 01 Q1
0.7
-4 -2 0 2 4 6 8
Quarters before and after NBER Peak
12Figure 12
Profits / Investment in Equipment and Software
2.3
2.1
48 Q4
1.9
53 Q2
1.7 57 Q3
60 Q2
1.5 69 Q4
1.3 73 Q4
80 Q1
1.1 81 Q3
0.9 90 Q3
01 Q1
0.7
0.5
-4 -2 0 2 4 6 8
Quarters Before and after NBER Peak
Figure 13
3 Month Treasury Bill Interest Rate NBER Recessions
1.6
1.4
48 Q4
1.2 53 Q2
57 Q3
1 60 Q2
69 Q4
0.8
73 Q4
0.6 80 Q1
81 Q3
0.4 90 Q3
0.2 01 Q1
0
-4 -2 0 2 4 6 8
Quarters before and after NBER Peak
13Figure 14
S and P Index / GDP Price Deflator During NBER Recessions
1.6
1.5
48 Q4
1.4
53 Q2
1.3 57 Q3
1.2 60 Q2
69 Q4
1.1
73 Q4
1 80 Q1
0.9 81 Q3
0.8 90 Q3
01 Q1
0.7
0.6
-4 -2 0 2 4 6 8
Quarters before and after NBER Peak
Figure 15
UCLA Accurately Predicted the Current Slowdown
and the Blue Chip Forecasters Missed It
3.5
3
2.5
2 Blue Chip Consensus
Blue Chip Bottom 10
1.5
Actual
1 UCLA
0.5
0
-0.5
2000:4 2001:1 2001:2
14Figure 16 Forecasts
Growth Unemployment Rate
7.0 7.0
6.0 6.0
5.0
4.0 5.0
3.0 4.0
2.0 3.0
1.0
2.0
0.0
-1.0 1.0
-2.0 0.0
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
2000 2001 2002 2000 2001 2002
Rate 3M Inflation
7.0 4.5
6.0 4.0
3.5
5.0
3.0
4.0 2.5
3.0 2.0
2.0 1.5
1.0
1.0
0.5
0.0 0.0
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
2000 2001 2002 2000 2001 2002
15Tables
Table 1
Properties of US Recessions
NBER Business Cycle Dates Average
NBER Peak Quarter 48 Q4 53 Q2 57 Q3 60 Q2 69 Q4 73 Q4 80 Q1 81 Q3 90 Q3
NBER Trough Quarter 49 Q4 54 Q2 58 Q2 61 Q1 70 Q4 75 Q1 80 Q3 82 Q4 91 Q1
Quarters to NBER Trough 4 4 3 3 4 5 2 5 2 3.6
Real GDP
GDP Reduction -1.7% -2.7% -3.7% -1.1% -0.1% -3.4% -2.2% -2.9% -1.3% -2.1%
Quarters to GDP Bottom 2 3 2 2 4 5 2 4 2 2.9
Quarters to Restore GDP Level 3 3 3 2 1 3 2 3 3 2.6
Total Quarters 5 6 5 4 5 8 4 7 5 5.4
Employment
Employment Reduction -1.9% -2.3% -2.3% -0.7% 0.1% -1.0% -1.0% -1.4% -0.9% -1.3%
Quarters to Employment Bottom 3 5 3 4 NA 6 2 5 4 4.0
Quarters to Restore Employment 3 3 4 3 NA 2 2 3 4 3.0
Total Quarters 6 8 7 7 NA 8 4 8 8 7.0
Unemployment Rate
Increase in Unemployment Rate 81.7% 132.5% 74.0% 33.8% 66.4% 86.0% 69.3% 44.1% 33.9% 69.1%
Quarters to Unemployment Peak 4 5 3 4 5 6 11 5 8 5.7
Quarters to Restore Unemployment* 5 4 4 4 1 12 6 6 9 5.7
Total Quarters 9 9 7 8 6 18 17 11 17 11.3
*Or termination of fall in unemployment.
16Table 2
Real Gross Domestic Product
[Billions of chained (1996) dollars]
Seasonally adjusted at annual rates
Average Change Change During Slowdown Difference in Difference
Four Quarters Ending Compared with 2000-III Annual
1999-III 2000-III 2000-IV 2001-I 2001-II 2000-IV 2001-I 2001-II
GROSS DOMESTIC PRODUCT 85.8 97.2 43.8 30.6 3.9 -53.4 -66.5 -93.3
Decelerating Components
Equipment and software 31.1 25.7 -3 -11.6 -43.6 -28.7 -37.3 -69.3
Consumer nondurables 18.8 23.9 2.7 11.2 1.9 -21.2 -12.7 -22.0
Structures -2.5 6.3 5.1 8.4 -10.3 -1.1 2.1 -16.6
Change in private inventories -8.1 3.0 -8.9 -69.9 -11.3 -11.9 -72.9 -14.3
Services 29.6 31.6 48.6 16.3 23 17.0 -15.3 -8.6
Consumer durables 25.0 19.2 -4.7 23 16 -23.9 3.8 -3.2
Accelerating Components
Federal Government 3.0 1.2 6.1 4.3 2 4.9 3.1 0.8
Residential Investment 4.7 -0.5 -1 7.6 5.2 -0.5 8.1 5.7
State and local government 7.8 7.9 6.7 16.2 18.8 -1.2 8.3 10.9
Net exports of goods and services -23.0 -19.5 -9.9 16.6 -6 9.6 36.1 13.5
17Table 3
Actuals and Forecasts
12-Sep-01
Year
Growth Unemploy Rate 3M Rate 10Y Spread Hours Inflation Inflow
Q1 2000 2.3 4.0 5.5 6.5 1.0 41.8 3.9 4.1%
Q2 5.7 4.0 5.7 6.2 0.5 41.8 2.2 4.2%
Q3 1.4 4.0 6.0 5.9 -0.1 41.5 1.9 4.5%
Q4 1.9 4.0 6.0 5.6 -0.5 41.1 1.8 4.5%
Q1 2001 1.3 4.2 4.8 5.1 0.2 41.0 3.3 4.1%
Q2 0.2 4.5 3.7 5.3 1.6 40.8 2.3 4.0%
Q3 -1.2 4.9 3.5 4.9 1.3 40.6 2.7 3.6%
Q4 -1.0 5.4 3.5 4.6 1.1 40.4 2.9 3.2%
Q1 2002 0.1 5.9 3.2 4.4 1.2 40.3 2.9 2.9%
Q2 1.4 6.2 3.1 4.4 1.3 40.3 2.7 2.6%
Q3 3.7 6.4 2.8 4.5 1.7 40.4 2.5 2.4%
Q4 4.3 6.4 2.8 4.7 1.9 40.5 2.4 2.1%
Q1 2003 4.4 6.3 3.0 5.0 1.9 40.6 2.5 1.9%
Q2 4.5 6.1 3.2 5.2 2.0 40.7 2.5 1.7%
Q3 4.5 6.0 3.4 5.4 2.0 40.8 2.6 1.5%
Q4 4.4 5.9 3.6 5.6 2.0 40.9 2.7 1.4%
18Endnotes
i
The market failure that is often thought to drive the Keynesian model of the business cycle is “sticky
prices,” an assumption that seemed to satisfy a generation of economists from 1950 to 1980, but inquiring
minds now want to know “why?”. Absent a compelling answer to that question, an influential Minnesota
sect led by Ed Prescott has argued that it is better to assume that there are no market pathologies and that
the cycle is merely the result of the efficient transmission of technological shocks; thus “real business
cycles.” I think that is impossible to square the real business cycle view with the fact that the cycle is
mostly about durables: cars, and computers and houses and office buildings. My own view of the cycle
refers to two “sticky-price” phenomena: (1) intertemporal pricing of new durable goods and (2) problems
with selling the options that are bundled with any existing durable.
(1) Producers of durable goods like automobiles have an incentive to maintain high prices during an
economic slowdown for two reasons. First, a reputation for maintaining value is a critical asset that cannot
be sacrificed with aggressive price-cutting during a slowdown. Secondly, the demand for durables tends to
become more inelastic in a downturn since it is the wealthier less-price-sensitive customers who remain.
This inelasticity encourages suppliers to maintain high prices.
(2) Owning today a house and a car and my human capital (if unemployed), I have the option to sell at any
time in the future. If I sell the asset today, I also surrender that option. When the transactions costs are
high, that option can be worth a great deal. The problem during the cycle is that sellers and buyers have
different horizons and consequently very different evaluations of these options. Sellers have a horizon of
at most a year or two during which they want to sell their home, or their car or make a commitment to a
new employer. But the buyers have an entirely different horizon in mind since to exercise that option they
must pay the transactions costs twice; thus buyers may not be thinking of selling again for five or ten years.
Consequently, buyers are not interested in purchasing an option to sell in the next year. For this reason,
sellers of assets during a downturn place a much higher value on the option to sell in the near future and no
transaction can occur since the seller values the asset-cum-option more highly than the buyer.
Think about housing, for example. During a downturn, the transactions volumes of existing
homes drop dramatically as homeowners choose to keep their options open. Prices of existing homes are
supported by this reduction in supply, and also by new home builders unwillingness to cut prices
dramatically.
ii
The adjective “unwanted” recognizes that some significant amount of idleness is desirable, and neither
people nor machines are expected to operate 24/7/365. A recession occurs when the level of idleness
exceeds that desirable level. By the way, it is possible to have a slowdown that is not a recession. That’s a
collective vacation that leaves labor and capital idle. Today, while manufacturing capital is experiencing
unwanted idleness, the twenty-something dot-comers as well as the forty-something assembly line workers
may be having a much deserved breather after four years of high-paced work.
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