Thoughts on politics and life from a liberal perspective

Thursday, 26 January 2012

Why is a recession a recession?

Consider these two hypothetical scenarios for GDP in the economy:

Q1: -0.7%
Q2: +0.1%
Q3: +0.1%
Q4: -0.5%

and secondly:

Q1: +0.7%
Q2: -0.1%
Q3: -0.1%
Q4: +0.5%

The two scenarios are essentially mirror images of each other with the signs inverted. I am assuming that in Q4 of the preceeding year and Q1 of the following year there is positive growth.

The curious thing is that the first scenario would not technically be considered a recession. There is one quarter of negative growth (-0.7%) followed by two quarters of only just positive growth (+0.1% each time) followed by a final quarter of negative growth again. Beause a recession is defined as two consecutive quarters of negative growth, the non-contiguous nature of the quarters where growth was negative means the dreaded word "recession" cannot be applied.

The second scenario however does fall into the definition of a recession. This is because despite relatively good growth in Q1 and Q4 there are (just) two quarters of negative growth in succession in Qs 2 and 3.

The crazy thing is, in the first scenario, during the year where there is no recession overall growth is -1%. Whereas in the second "recession" scenario growth is +1%!

Some may say this is all a bit technical and doesn't matter but it does. Because words make a big difference. In the second scenario, the media would be all over the "fact" that the country had tipped into recession, there would be all sorts of news reports about it and of course opposition politicians would make as much political capital as possible out of it. This in turn damages confidence and actually makes further contraction more likely.

So the definition of "a recession" seems like it is a little bit inflexible. In the scenarios it is clearly the first one that is worst for the economy and we surely need a way to reflect that? Something that perhaps looks at the trend across three or four quarters and takes the average to see if things are negative might be a bit fairer perhaps?

I would be interested in hearing thoughts from others about this and perhaps a justification of why the current system (which apparently evolved from an article by an economic statistician in the New York Times in 1975) is the best.

I think I may take some convincing!

1 comment:

Mark Wadsworth said...

Because that is how a recession is defined. Somebody somewhere has to make up the rules for what counts as a recession and those are the rules.

In real life, the rules are meaningless, AFAICS, the recession which started in the early 1970s lasted until the mid 1990s, others might beg to differ.