4/23/2017 Recession: When Bad Times Prevail - Back to Basics: Finance & Development

Recession:WhenBadTimesPrevail
FINANCE & DEVELOPMENT

StijnClaessensandM.AyhanKose

Itisasustainedperiodwheneconomicoutputfallsandunemploymentrises

Followingtheonsetoftherecentglobaleconomiccrisis,
muchofthenews,especiallyinadvancedeconomies,was
dire.Unemploymentwasrising,companyprofitswere
falling,financialmarketsweretumbling,andthehousing
sectorcollapsed.Isthereasinglewordtodescribethese
developments?Yes:recession.

Thecrisiswasaccompaniedbyrecessionsinmany
countries.Thispatternisconsistentwiththehistorical
record.Simultaneous,orsynchronized,recessionshave Whowillwatertheplants?(photo:Zuma
occurredinadvancedeconomiesseveraltimesinthepast Press/Newscom)

fourdecadesthemid1970s,early1980s,early1990s,andearly2000s.BecausetheUnited
Statesistheworldslargesteconomyandhasstrongtradeandfinanciallinkageswithmany
othereconomies,mostofthesegloballysynchronizedrecessionepisodesalsocoincidewithU.S.
recessions.

AlthoughU.S.recessionshadbecomemilderover
time,therecentglobalcrisisreversedthattrend. What Is a Recession?
Thelatestepisodewasoneofthelongestand
deepestrecessionssincetheGreatDepressionof
the1930s.Itledtoasharpincreasein
unemploymentalongwithsubstantialdeclinesin
output,consumptionandinvestment.

Callingarecession

Thereisnoofficialdefinitionofrecession,butthereisgeneralrecognitionthatthetermrefersto
aperiodofdeclineineconomicactivity.Veryshortperiodsofdeclinearenotconsidered
recessions.Mostcommentatorsandanalystsuse,asapracticaldefinitionofrecession,two
consecutivequartersofdeclineinacountrysreal(inflationadjusted)grossdomesticproduct
(GDP)thevalueofallgoodsandservicesacountryproduces.Althoughthisdefinitionisauseful
ruleofthumb,ithasdrawbacks.AfocusonGDPaloneisnarrow,anditisoftenbetterto
considerawidersetofmeasuresofeconomicactivitytodeterminewhetheracountryisindeed
sufferingarecession.Usingotherindicatorscanalsoprovideatimeliergaugeofthestateofthe
economy.

IntheUnitedStates,theprivateNationalBureauofEconomicResearch(NBER),whichmaintains
achronologyofthebeginningandendingdatesofU.S.recessions,usesabroaderdefinitionand
considersanumberofmeasuresofactivitytodeterminethedatesofrecessions.TheNBERs
BusinessCycleDatingCommitteedefinesarecessionasasignificantdeclineineconomicactivity
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spreadacrosstheeconomy,lastingmorethanafewmonths,normallyvisibleinproduction,
employment,realincome,andotherindicators.Arecessionbeginswhentheeconomyreachesa
peakofactivityandendswhentheeconomyreachesitstrough.Consistentwiththisdefinition,
theCommitteefocusesonacomprehensivesetofmeasuresincludingnotonlyGDP,butalso
employment,income,sales,andindustrialproductiontoanalyzethetrendsineconomic
activity.

Althoughaneconomycanshowsignsofweakeningmonthsbeforearecessionbegins,the
processofdeterminingwhetheracountryisinatruerecessionoftentakestime.Forexample,it
tooktheNBERcommitteeayeartoannouncethebeginningandenddatesofthemostrecent
U.S.recession.Thisisunderstandable.Thedecisionprocessinvolvesestablishingabroaddecline
ineconomicactivityoveranextendedperiodoftime,aftercompilingandsiftingthroughmany
variables,whichareoftensubjecttorevisionsaftertheirinitialannouncement.Inaddition,
differentmeasuresofactivitymayexhibitconflictingbehavior,makingitdifficulttoidentify
whetherthecountryisindeedsufferingfromabroadbaseddeclineineconomicactivity.

Whydorecessionshappen?

Understandingthesourcesofrecessionshasbeenoneoftheenduringareasofresearchin
economics.Thereareavarietyofreasonsrecessionstakeplace.Someareassociatedwithsharp
changesinthepricesoftheinputsusedinproducinggoodsandservices.Forexample,asteep
increaseinoilpricescanbeaharbingerofarecession.Asenergybecomesexpensive,itpushes
uptheoverallpricelevel,leadingtoadeclineinaggregatedemand.Arecessioncanalsobe
triggeredbyacountrysdecisiontoreduceinflationbyemployingcontractionarymonetaryor
fiscalpolicies.Whenusedexcessively,suchpoliciescanleadtoadeclineindemandforgoods
andservices,eventuallyresultinginarecession.

Otherrecessions,suchastheonethatbeganin2007,arerootedinfinancialmarketproblems.
Sharpincreasesinassetpricesandaspeedyexpansionofcreditoftencoincidewithrapid
accumulationofdebt.Ascorporationsandhouseholdsgetoverextendedandfacedifficultiesin
meetingtheirdebtobligations,theyreduceinvestmentandconsumption,whichinturnleadstoa
decreaseineconomicactivity.Notallsuchcreditboomsendupinrecessions,butwhentheydo,
theserecessionsareoftenmorecostlythanothers.Recessionscanbetheresultofadeclinein
externaldemand,especiallyincountrieswithstrongexportsectors.Adverseeffectsofrecessions
inlargecountriessuchasGermany,Japan,andtheUnitedStatesarerapidlyfeltbytheir
regionaltradingpartners,especiallyduringgloballysynchronizedrecessions.

Becauserecessionshavemanypotentialcauses,itisachallengetopredictthem.Thebehavioral
patternsofnumerouseconomicvariablesincludingcreditvolume,assetprices,andthe
unemploymentratearoundrecessionshavebeendocumented,butalthoughtheymightbethe
causeofrecessions,theycouldalsobetheresultofrecessionsorineconomicparlance,
endogenoustorecessions.Eventhougheconomistsusealargesetofvariablestoforecastthe
futurebehaviorofeconomicactivity,nonehasprovenareliablepredictorofwhetherarecession
isgoingtotakeplace.Changesinsomevariablessuchasassetprices,theunemploymentrate,
certaininterestrates,andconsumerconfidenceappeartobeusefulinpredictingrecessions,but
economistsstillfallshortofaccuratelyforecastingasignificantfractionofrecessions,letalone
predictingtheirseverityintermsofdurationandamplitude.

Recessionsareinfrequentbutcostly

Therewere122completedrecessionsin21advancedeconomiesoverthe19602007period.
Althoughthissoundslikealot,recessionsdonothappenfrequently.Indeed,theproportionof
timespentinrecessionmeasuredbythepercentageofquartersacountrywasinrecessionover
thefullsampleperiodwastypicallyabout10percent.Althougheachrecessionhasunique
features,recessionsoftenexhibitanumberofcommoncharacteristics:

Theytypicallylastaboutayearandoftenresultinasignificantoutputcost.Inparticular,a
recessionisusuallyassociatedwithadeclineof2percentinGDP.Inthecaseofsevere
recessions,thetypicaloutputcostiscloseto5percent.

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Thefallinconsumptionisoftensmall,butbothindustrialproductionandinvestmentregister
muchlargerdeclinesthanthatinGDP.

Theytypicallyoverlapwithdropsininternationaltradeasexportsand,especially,importsfall
sharplyduringperiodsofslowdown.

Theunemploymentratealmostalwaysjumpsandinflationfallsslightlybecauseoveralldemand
forgoodsandservicesiscurtailed.Alongwiththeerosionofhouseandequityvalues,recessions
tendtobeassociatedwithturmoilinfinancialmarkets.

Whataboutadepression?

ThelatestU.S.recessionwhichbeganinDecember2007andendedinJune2009wasthe
longest(18months)anddeepest(abouta3.7percentdeclineinoutput)thecountryhas
experiencedsince1960.ThetypicalU.S.recessionpriorto2007lastedabout11monthsand
resultedinapeaktotroughoutputdeclineof1.7percent.Althoughinvestmentandindustrial
productionfellineveryrecession,consumptionregisteredadeclineinonlyfouroutofeight
episodessince1960.

Onequestionsometimesaskedishowarecessioncompareswithadepression,especiallythe
GreatDepressionofthe1930s.Thereisnoformaldefinitionofdepression,butmostanalysts
consideradepressiontobeanextremelysevererecession,inwhichthedeclineinGDPexceeds
10percent.Therehavebeenonlyahandfulofdepressionepisodesinadvancedeconomiessince
1960.Themostrecentwasintheearly1990sinFinland,whichregisteredadeclineinGDPof
about14percent.ThatdepressioncoincidedwiththebreakupoftheSovietUnion,alargetrading
partnerofFinland.DuringtheGreatDepression,theU.S.economycontractedbyabout30
percentoverafouryearperiod.Althoughthelatestrecessionisobviouslysevere,itsoutputcost
wasmuchsmallerthanthatoftheGreatDepression.

StijnClaessensisanAssistantDirectorandM.AyhanKoseisanAssistanttotheDirectorinthe
IMFsResearchDepartment.

References

Claessens,Stijn,M.AyhanKose,andMarcoTerrones,2009,WhatHappensDuringRecessions,
Crunches,andBusts?EconomicPolicy,Vol.60,pp.653700.AlsoIMFWorkingPaper,No.08/274,
(Washington).

,2011a,FinancialCycles:What?How?When?forthcoming,NBER2010InternationalSeminar
onMacroeconomics,RichardClaridaandFrancescoGiavazzi(eds.).AlsoIMFWorkingPaper,No.
11/76(Washington).

,2011b,HowDoBusinessandFinancialCyclesInteract?IMFWorkingPaper,No.11/88,
(Washington).

Updated:March28,2012

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