20 August 2009

When does a recession end?

The recession is over. At least for France and Germany. One quarter of positive growth and all the press and media agree - the recession is finished. But is it?
How do we know that a recession is over? We know what a recession looks like - unemployment rising , falling orders, short time working, businesses closing down, GDP falling, tax receipts down, etc. How will we spot when it turns the corner?
GDP is an obvious indicator. When GDP is falling there is a recession and when growth returns it is finished. Sadly it is not so simple.
The chart shows quarterly growth for the UK from 1990. The economy shrank for five quarters beginning in the third quarter of 1990. GDP then grew slightly for two quarters before shrinking again. You might have thought that the recession was over by the end of 1991, but you would have been wrong. It didn't end at least until mid 1992. So one quarter (or even two) of GDP growth does not guarantee the end of the slump.
An alternative might be to look at the level of at GDP rather then the change. The UK economy grew to a peak in early 2008, since when is has been contracting. Is the recession over only when GDP again reaches the level it was in Q1 2008? If so then we have a long way to go. GDP has fallen by 5.7%. If growth returned to a normal rate (about 2.5% a year) it will take more than two years to get back to the pre-recession level.
Perhaps that is too strict a test. It might reflect reality if unemployment is our main concern, but then why not just use the unemployment figures.
The alternative which appeals to me for calling the end of the recession is when the annual growth rate turns positive, ie the growth over the last four quarters is positive. In the 1990s it is clear that this condition was not met until Q3 1992. Another criterion could be for quarterly growth to return to (or exceed) the trend rate (about 2.5% annually for the UK, or over 0.6% a quarter). On this condition the earlier recession ended in Q4 1992.
So, it is too early to be sure that either France or Germany has exited from recession. I will wait until one of these two conditions have been met.

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