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.

The End is Nigh?

What is wrong with this picture?



This is the Bank of England's projection for economic growth taken from the August Inflation Report published last week. At first sight it would appear to be good news. It shows a strong recovery from recession. Here we have a V shaped and not a U shaped or W shaped or even an L shaped recession. So what is the problem?

The first problem is that in the press conference, Mervyn King , the bank's governor, warned of a fragile recovery, "The pace of recovery over the next few years is highly uncertain." (See the BBC) The fan chart, on the other hand sees growth back to normal levels next year.

The next problem is interpreting the chart. This shows the annual growth rate, or more accurately, the 4 quarter growth rate. So when the central projection crosses the zero, as it does early in 2010, then the growth rate over the last four quarters is zero; ie the economy is the same size as it was in early 2009.

(Another difficulty is that it looks like the ONS data is only available up to the first quarter of 2009, but from the shape it is obvious that the latest data (Q2 2009) is included. See here) Reading off from the chart, annual GDP reaches about 1% at the end of Q1 2010.

This is where it gets interesting. GDP fell by 0.8% in the second quarter of 2009. So to get to 1% in March next year, the economy must grow by over 1.8% over the next three quarters, equivalent to an annual growth rate of 2.4%. So either the economy grows at its trend rate from now on, or it grows faster than its trend rate in the early months of 2010.

I know that the monetary policy committee is stuffed with people who know more about economics than I ever will. But I can't see how this projection is possible.

If there is a choice between an optimistic chart and a pessimistic governor, I'm with the governor.

SproutWatch July

The green shoots are wilting before our eyes. Even in the press the sprouts are harder to find. My traffic lights this month are unchanged:


Banking crisis: The index (the spread of 3 month sterling LIBOR over the policy rate) is down to 54bp from 76bp last month. The target is 10bp. The banking crisis is far from over.


Debt/demand crisis: The index (economic growth forecast for 2010) is 1.1% up from 0.6% last month. To be on track for recovery it should be upwards of 2%. The recovery is still some way off.


Trade crisis: My trade index is 5.9% down from 6.3%. (The index sums the deficits and surpluses of four major trading economies and divides by their combined GDP.) Looking up, but the recession is cutting the level of trade. We need to watch what happens when the recovery begins.

For more information on the indices see the small print here.

SproutWatch - June

First posted on 7 June 2009:

SproutWatch is my occasional blog looking for signs of the "green shoots" of recovery. If I see any sprouting of green shoots, I will mark the occasion with with a green light, but until then we will make do with red and occasionally amber.

Banking crisis: The index is at 0.70% down from 0.77% last week. (See the small print below for an explanation.) A recovery from the banking crisis would mean a number in single figures. So for now we are still on red.


Debt/demand crisis: The Economist forecast for growth in 2010 is 0.6% up from 0.3% last month . If the economy was to recover next year then we should see growth over 2%. So the prospect for recovery soon is a big red sprout from Brussels.

Trade crisis: The trade imbalance is unchanged at 6.3%.

Second derivative
Notice that two of the indicators have improved. They still signal that the downturn will continue, but they are better than last time. This partly explains why some commentators see green shoots and why they are wrong. In maths, this is called the second derivative. Basically the indicators are saying the economy is shrinking, but not as fast as before.

Here is an example from this weeks Economist:"The rich world’s manufacturing slump may be coming to an end." That sounds good. "In America, the Institute for Supply Management’s activity index rose from 40.1 to 42.8 in May..." Good, the index is going up.Then in brackets, "(a reading above 50 indicates industry is expanding)" So a reading of 42.8 means industry is contracting.

Small print
The banking crisis is measured by the risk premium banks demand when they lend to each other. The index is the difference between the interest rate for inter-bank lending (3 month sterling LIBOR) and the policy rate set by the Bank of England.

The debt/demand indicator is the forecast published by the Economist newspaper, based on the forecast of a dozen or so institutions.

The trade crisis indicator is the sum of the trade deficits of the US and UK plus the trade surpluses of China and Germany (on the basis of the latest 12 months for which figures have been published) expressed as a percentage of their combined GDP.

Crisis, Which Crisis

Here is a repost from my other blog. This first appeared on 16 Feb 2009.

It seems to me that behind the economic slump is not just one crisis but, at least, three:

• a banking crisis;
• a debt /demand crisis; and
• a trade crisis.

Of course they are linked - each impacting on the other – but dealing with the slump means responding to all three crises at the same time. My argument is that fixing all three simultaneously will not be easy.

The banking crisis is the most talked about. Banks have “assets” which no-one wants to buy and so the true value, if they have any, is unknown. Consequently the solvency of the banks is in doubt, and so interbank lending froze up two years ago and banks remain stuck.

The solution is to get the doubtful assets off the banks balance sheets. Recapitalising and offering insurance on bad loans might work, but the only sure way is too strip out the bad stuff and lodge it in a “bad bank”. If nationalisation is the only way to clean up the banks then so be it.

The debt crisis is more interesting. I keep reading - usually accompanied by expressions of shock – that total UK debt had reached 300% of GDP. But debt amounting to 3 times annual income is not that strange. If you have ever had a mortgage then you were probably allowed to borrow three times your income. The real crisis is that the appetite for risk has gone. Businesses and households want to hold cash rather than make risky investments. So there is a huge switch from lots of debt and credit to everyone trying to reduce their debts and increase saving.

This is the classic Keynesian crisis and the solution begins by expanding the money supply. But, partly because the banks aren’t doing their job and partly because people are holding on to cash, it isn’t working. The Bank of England is expanding the money supply as much as it can but broad measures of money are barely growing.

The other solution is for the government to borrow and spend – fiscal stimulus. The government is on the case, but I think it needs to do more.

The trade crisis has been developing for some years. Britain, the US and some other countries have been running large current account deficits, while others – like China and other Asian countries – have been running current account surpluses. The other side of the coin is that while trade flows go one way financial flows go the other. The surplus countries in effect lend their money back.

The solution to this one is for Britain, the US etc to save more and for China, etc to consume more. That may not be obvious, but as a matter of economic arithmetic, domestic savings less investment is equal to the trade balance; so more savings means less of a trade deficit.

Now I can see a difficulty here. Can the government deal with the second crisis and the third crisis at the same time? If government borrows enough to keep the economy going then it simply replaces the borrowing which firms and households no longer undertake, and the trade position will not improve.

The real answer to the trade imbalance is for the surplus countries to save less or borrow more (which is the same thing). So China’s fiscal stimulus and Germany’s fiscal stimulus are more important to the recovery than our own.