What is a Recession?

We never want to hear the dreaded words - the U.S. is in a recession. A recession is a technical term used to describe a period in which there is a significant decline in economic activity and is often associated with job loss, economic pain, and financial hardship.

Since 1945, the U.S. has officially experienced 13 recessions, with the average recession lasting 10 months and the average expansion lasting 64 months.

Post-Great Financial Crisis, beginning in July 2009, the U.S. economy experienced its longest expansion on record, lasting nearly 11 years. The expansion was ultimately disrupted by a global pandemic when the shortest recession on record began in February 2020 and ended just two months later.

Contrary to popular belief, a recession is not identified solely by two consecutive quarters of negative real GDP. Instead, a recession is officially recognized in the United States when the National Bureau of Economic Research (“NBER”) declares that there has been a significant decline in economic activity, and the dates of peak and trough months are identified.

The NBER was founded in 1920 by Malcolm Rorty and Nachum Stone, who together agreed that there was minimal data on which to discuss economic policy issues. As such, they formed the NBER and assembled a group of researchers to address this information gap and improve the measurement of economic data.

In 1978, Martin S. Feldstein, President, formed the NBER Business Cycle Dating Committee, chaired by Robert Hall, to track turning points in economic activity and carry forward the NBER’s long-standing role in business cycle analysis. The committee is tasked with maintaining a chronology of U.S. business cycles and identifying the dates of peak and trough months in economic activity.

The NBER defines a recession as a significant decline in economic activity that is spread across the economy and lasting more than a few months. The interval between the peak and the trough designates a recession and the period following the trough is designated as an expansion. Notably, recessions and expansions refer to the direction of change in economic activity, as opposed to the level of activity.

To classify a period as a recession, the committee needs to observe each of the three criteria: depth, diffusion, and duration. Although they seek to observe each criterion to some extent, extreme conditions revealed by one criterion may offset indications from another.

In the NBER’s methodology for measuring the duration of a recession, the first month of the recession is the month following the peak and the last month is the month of the trough. The peak is the highest point of economic activity before beginning to fall and the trough is the lowest point before economic activity picks back up.

For example, the recession in 2020 began with a peak in February 2020 and a trough in April. Because March was the first month of the recession and April was the last, the recession was determined to last two months according to the NBER.

The determination of peak and trough months are based on a range of monthly measures of aggregate real economic activity published by federal statistical agencies. These measures include the following economic statistics:

• FRED real personal income less transfers

Real personal income excluding current transfer receipts

• FRED nonfarm payrolls
• FRED real personal consumption expenditures
• FRED real manufacturing and trade industries sales
• FRED household employment
• FRED index of industrial production

In addition, the committee also makes a separate determination of the calendar quarter of a peak or trough, based in part on the below measures of aggregate economic activity over the relevant quarters.

• FRED real GDP

Real Gross Domestic Product

• FRED real GDI

Although these measures are used as insightful indicators of economic activity, they should be highly scrutinized and analyzed in context, because different data points indicate different things during different economic cycles.

For the business cycle peak in February 2020, the peak in payroll employment occurred in that month, whereas in 2008, employment reached its peak one month after the business cycle peak in December 2007.

In other cases, certain indicators that may be less significant can become more relevant based on that cycle. For example, household employment is usually a more reliable indicator of labor market conditions than unemployment insurance claims.

In March 2020, however, due to the methodology for calculating employment, NBER stated that the March employment rate published in April 2020 did not capture the deep economic decline that occurred during the second half of that month. Instead, the committee relied more heavily on the significant increase in unemployment insurance claims, suggesting a deep collapse in employment between the household employment reference week and the end of March.

Despite the industry’s efforts to compare one recession to another, the NBER does not distinguish one recession from the next. Despite the breadth or nature of the decline, there are no special categories such as depressions or double-dip recessions.

The NBER carefully considers whether a period is two separate recessions or part of the same recession, based primarily on whether the period experienced a material uptick in economic activity that could warrant two separate recessions.

The industry is also known for using two consecutive quarters of decline in real GDP as an indicator of recession, however, the committee does not accept or use this as the definition of recession. One reason is that real GDP could decline by relatively small amounts in two consecutive quarters but is not evidence of a period that experienced a material economic decline. And when considering quarterly production, the committee gives equal weight to gross domestic income as it does to gross domestic product.

Notably, most of the recessions identified by the committee have consisted of two or more consecutive quarters of decline in real GDP. The recession in 2001 is an exception to the rule, where the committee determined there to be a recession from March 2001 to November 2001 but did not include a period with two consecutive negative quarters.

A recession is a technical term used to describe a period in which there is a significant decline in economic activity. The NBER’s Business Cycle Dating Committee, which maintains a chronology of U.S. business cycles, is responsible for identifying the dates of peak and trough months in economic activity.

It takes a very astute and attentive eye to dissect the various economic indicators and understand how those data points speak to various movements in the economy around a general business cycle. This is a very challenging process as it has historically taken the committee between 4 and 21 months to determine whether a recessionary period has occurred.

This significant uncertainty requires investors to diversify their assets and invest their capital with institutional asset managers that are capable of navigating the business cycle and the challenging market environment that comes along.

Sources:
NBER, August 2022. "Business Cycle Dating Procedure: Frequently Asked Questions"
NBER. "History"
NBER. "US Business Cycle Expansion and Contractions"
Bloomberg, August 2022. "Here’s What the Six Key Official Indicators of US Recession Show"