Technically speaking

Stephen Stanley | July 15, 2022

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Commentators and media lately have coined a new phrase: technical recession.   It refers to the fact that real GDP contracted in the first quarter and may have done so again in the second, at least if you believe the Atlanta Fed GDPNow estimate. The idea would seem to be that this would technically put the economy in a recession even if it does not meet all the traditional yardsticks for a downturn. But economists have never recognized a technical recession.  Back-to-back quarters of negative GDP is merely a rule of thumb used by casual observers as a rough proxy for a recession, not a binding definition. A recession entails broad-based and persistent contraction of activity. The first half of 2022 most assuredly does not fit that description.

Recession arbiters

The official arbiters of business cycle dates are the eight members of the National Bureau of Economic Research’s Business Cycle Dating Committee.  The panel was first established in 1978 by then-NBER President Martin Feldstein and has become the universally acknowledged authority on dating economic turning points.  Its members are academic economists and meet privately, far from the frenzied media and financial market environments.  Often, the beginning and end of recessions are not declared until well after the fact, as the academics wait for lagged data and revisions to fill in the picture completely and allow an accurate accounting. Turning points are rarely obvious in real time.

The NBER committee’s web site explains how it defines a recession: “The NBER’s definition emphasizes that a recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months.”  The three defining criteria are depth, diffusion and duration.  The committee determines business cycle dates on both a monthly and quarterly basis.

The Committee goes on to note that it uses economy-wide measures to assess the business cycle.  The key monthly indicators examined are:

• Real personal income less transfers
• Nonfarm payroll employment
• Household survey employment
• Real personal consumption expenditures
• Real wholesale and retail sales
• Industrial production

For its quarterly dating, the committee looks at the quarterly averages of the above monthly figures and also real GDP and real Gross Domestic Income (GDI).

The Committee notes that in recent decades, it has put the most weight on the real personal income less transfers and payroll employment figures.

Tale of the tape

Starting with the monthly indicators, all six point to considerable growth in the first half of the year.

• Real personal consumption expenditures rose at an annualized pace of just over 1.5% from December to May. On a quarterly basis, the first quarter posted a 1.8% annualized gain while the second is on track for around a 1.5% rise.
• Real personal income less transfers is the weakest of the six. It has risen on balance in the first five months of the year, but the annualized gain is less than 1%.
• Real wholesale and retail sales: wholesale sales have increased at an explosive pace so far this year, nearly 10% over the first five months of the year, an annualized pace of over 25%. Retail sales in the first five months of the year rose at better than a 15% annualized pace.  Even with sky-high inflation, these gains are still hefty in real terms.
• Industrial production has increased at an 8.3% annualized pace in the first five months of the year (note that industrial production is measured in physical units instead of dollars, that is, it is already in real terms and does not need to be deflated).
• Payroll employment growth has averaged 457,000 a month in the first six months of the year, a historically strong performance.
• Household employment growth has averaged 356,000 a month, also an unusually robust result.

Even when we shift to quarterly, the GDP figure for the first quarter is an outlier.  Real gross domestic income increased at a 1.8% annualized pace in the first quarter.  Recently, St. Louis Fed President Bullard noted that the gross domestic income figures are likely providing the superior signal in light of the strength in the labor market.

The negative first quarter GDP figure, and prospect of a possible second quarter decline, is not backed up by any of the other indicators that the NBER committee typically looks at.  Even the first quarter drop in real output was narrowly focused, driven by a massive widening in the trade gap.  Real final sales to domestic purchasers, which excludes inventories and trade, posted a 2.0% annualized increase in the first quarter, which was stronger than the performance in the third and fourth quarters of last year.  Moreover, the other big negative contributor to first quarter real GDP was federal government outlays, not a fair indicator of activity in the broader economy.  Real consumer spending registered a decent gain (1.8%), while business fixed investment surged ahead at a 10% annualized clip, and even housing eked out a small advance. Consequently, even the first quarter GDP figures do not fit the NBER’s criterion of a decline spread across the economy.

Technically speaking

In sum, even if second quarter real GDP manages to print negative, delivering back-to-back negative quarters—and be aware that there will be annual benchmark revisions released with the second quarter figures, so the first quarter could, in theory, be revised into positive territory—a broader reckoning of the economy for the first half of the year points to solid growth, not the onset of a recession. Of course, this does not mean that the discussion of whether the economy is already in recession taking place in the press and even among financial market participants will stop.  I suppose only a positive second quarter real GDP print can do that.