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Inside the American struggle with rising energy prices
03:08 - Source: CNNBusiness

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CNN  — 

The number of relatively frightening headlines about the economy and the likelihood of a recession is on the rise, especially after government data released Thursday showed the economy shrank in the first quarter of 2022.

The word “recession,” which generally refers to the downswing in a business cycle, has an ugly ring to it. A down economy is obviously painful for a lot of people to live through, even if it is a natural part of the business cycle.

But while you’re likely to see the term “recession” thrown around a lot in the weeks and months to come, the exact definition is not so simple. It is technically possible that despite extremely low unemployment and other strong economic indicators, the US is in a recession right now and nobody has realized it yet.

Predicting if and when a recession will strike is hard – even if the storm clouds always seem so obvious in hindsight.

What could cause a recession now?

Inflation, or rising costs, is at a 40-year high, which eats into what people can buy.

What’s likely to cause a recession is the Federal Reserve’s plan to fight inflation by raising interest rates.

Fed Chairman Jerome Powell has argued that with targeted interest rate hikes, policymakers can engineer a “soft landing” – controlling inflation without triggering a recession.

If there’s a recession, who would be to blame?

If a recession occurs, some people will blame the Fed for not acting sooner to control it.

You could legitimately blame the pandemic for kinking supply chains, and Russia’s war on Ukraine for affecting energy and food costs.

One individual who will get a lot of blame – rightfully or not – is President Joe Biden, who would have to defend the sour economy on his watch.

What exactly is a recession?

I was taught the shorthand that a recession is simply a period marked by two consecutive quarters of negative growth in the gross domestic product. That turns out to be overly simple and not entirely accurate.

By this definition, the Covid-19 pandemic, which changed the world economy and hit pause on everyone’s life in early 2020, just barely caused a recession.

It turns out two consecutive quarters of declining GDP is just one indicator flagged by Julius Shiskin, who was head of the Bureau of Labor Statistics in the 1970s and tried to figure out how to identify a recession as it was occurring. As noted in The New York Times in 1974, he pointed to these factors:

  • Duration: Does nonfarm employment drop for at least nine months?
  • Depth: Does the gross national product decline by at least 1.5% for at least two quarters? And is there a rise in the unemployment rate of more than 2 points and to a level above 6%?
  • Diffusion: Does most of the economy – more than 75% of all industries – feel the pinch in employment for six months or longer?

Who officially decides if there’s a recession?

There will be plenty of people talking about a recession if the US economy turns.

But the undisputed referee is a private, non-profit organization founded by industrialists in 1920 – the National Bureau of Economic Research – which has a committee of eminent economists.

They meet regularly to look at a bunch of economic data and they decide if the current business cycle has reached either an economic peak (high point) or trough (low point). Recessions are the periods between the peaks and troughs.

When do they decide if there’s a recession?

While accurate and a good academic benchmark, the National Bureau of Economic Research is not forward-looking. The committee doesn’t predict recessions; it only marks them.

For instance, the bureau didn’t officially declare that the Covid-19 pandemic-induced recession had begun in February 2020 until June 2020, two months after it had technically ended.

Read all their determinations going back to 1979.

What exactly do they look at to decide if there’s a recession?

NBER doesn’t exactly say. This is from its website:

There is no fixed rule about what measures contribute information to the process or how they are weighted in our decisions.

The organization monitors a range of federal economic data – the same employment surveys and consumer spending reports everyone else sees – and its general definition of recession is this:

A significant decline in economic activity that is spread across the economy and that lasts more than a few months. The committee’s view is that while each of the three criteria—depth, diffusion, and duration—needs to be met individually to some degree, extreme conditions revealed by one criterion may partially offset weaker indications from another.

How long do recessions usually last?

Recessions are usually shorter than expansions. There had been more than 10 straight years of growth before the Covid-19 pandemic.

There had been six years of growth before the Great Recession struck in 2007. The Great Recession lasted 18 months, according to NBER.

Average expansions between World War II and the Covid-19 pandemic lasted about 65 months, and average recessions lasted about 11 months, according to the Congressional Research Service.

The Great Depression, meanwhile, kicked off with a 43-month recession that lasted from August 1929 to March 1933.

What’s the worst-case scenario right now?

Former Treasury Secretary Larry Summers, who accurately predicted rising inflation when the Fed was skeptical, now says “stagflation” is a real possibility.

What is stagflation? Imagine rising prices from inflation combined with a stagnant economy. The worst of both worlds.

“The Fed’s current policy trajectory is likely to lead to stagflation, with average unemployment and inflation both averaging over 5 percent over the next few years — and ultimately to a major recession,” Summers wrote in The Washington Post in March.

This story has been updated with additional information.