The “recession-no recession” debate took a new turn with the release this week of an academic paper that attempted to take the vague language of the National Bureau of Economic Research and turn it to a distinct mathematic formula.

The conclusion of the author, Prof. Edward Leamer of UCLA, is that, through June at least the current – and ongoing – economic downturn doesn’t pass the tests for a recession “and will do so only if things get much worse.”

First some background.

There is a definition of a recession – referred to by economists at the Philadelphia Federal Reserve Bank as a “folk definition” -- which looks for two consecutive quarters of negative growth as a standard to determine a recession.

The two quarters of negative growth, Leamer wrote, while a simple concept, doesn’t apply to the 2001 recession which the NBER said lasted from March through November that year. According to government statistics, economic growth was negative for three non-consecutive quarters from the third quarter of 2000 through third quarter 2001, only one of which came during the period described as a recession by NBER. The economy, according to government number-crunchers, contracted in the third quarter of 2000, the first quarter of 2001 and the third quarter of 2001 but grew in the fourth quarter of 2000 and second quarter of 2001.

The NBER, which has been given the task of dating business cycles -- in other words, determining when and if we are in a recession -- doesn’t use the simple two-quarter test. Instead NBER’s recession-dating committee looks not to quarterly reports of Gross Domestic Product, but rather some monthly indicators.

The NBER instead says “a recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income and wholesale-retail trade.”

Even though the NBER cites specific statistical measures, it doesn’t use a formula to determine if we are indeed in a recession. In fact, Leamer suggests in his paper, the determination of a recession is like Supreme Court Justice Potter Stewart’s famous explanation of pornography. Stewart acknowledged he was unable to formulate a definition of pornography but declared: “I know it when I see it.”

Then, too, there is the observation of Warren Buffett cited in Leamer’s paper: “By any common-sense definition, we are in a recession,” Buffet said. “Business is slowing down. We (Berkshire-Hathaway) have retail stores in candy, home furnishings and jewelry; across the board, I’m seeing a significant slowdown.”

Leamer set out to reduce the NBER judgment to hard numbers.

“Given the importance of having some clear definition of a recession,” Leamer wrote, “it is a little aggravating that the official recessions are decided by a committee of Ph.D. economists.”

Leamer, by the way is a Ph.D. economist.

“One reason we need a clear definition (of a recession) is that the media focus intensely on two questions: Is it a bear market? Are we in a recession?”

So, he said, he came up with his formula: “an algorithm that perfectly identifies the ten official NBER recessions since WWII and that closely reproduces the official NBER peak and trough dates.” (He acknowledged a difference with NBER in the November 1973-March 1975 recession: his formula suggests the economic peak was September 1974.)

Leamer looked specifically at two of the data sets used by NBER: industrial production and employment (both payroll jobs and household employment). The employment data, he said, “seem to identify recessions accurately,” but he offered another twist on that data. “Employment,” he wrote, “is a measurement of a physical reality – getting up in the morning and going to work. But unemployment is partly psychological, and can vary downward because job-seekers get discouraged or upward because of favorable expectations about finding a good job.”

He passed on the wholesale-retail trade and real income components and tried to construct an algorithm -- simply a set of rules for solving a problem in a finite number of steps – to pick “probable recessions. He looked specifically for a decline in industrial production for six months at the rate of 6% or more per year, a decline in payroll employment for six months at the rate of 1% or more per year and an increase in the unemployment rate in a sex month period of at least 0.8%.

“Every recession since World War II,” he concluded, “has included months that satisfied all three of this limits. And there has never been a time in the expansions during which all three of these limits were satisfied.”

And what about the economy today?

“The unemployment rate,” Leamer wrote, “satisfies the cutoff in one month – just barely – because of [the] sharp increase in May (when the unemployment rate when from 5.0% to 5.5%) but when June held steady, the six-month change backed off a bit….the problems in industrial production are nowhere close to the limit. Bottom line: things have got to get much worse to pass the recession threshold.”

The debate continues.
 

Mark Lieberman is the senior economist for the Fox Business Network. Prior to joining FOX, he served as first vice president and manager of economic analysis and research at Washington Mutual in New York. Before that, he served as senior vice president at Dime Savings Bank of New York (which was later acquired by Washington Mutual), where he specialized in credit and risk management. He is a member of the Executive Committee of the New York Association for Business Economics. He has a degree in Economics from the Wharton School of the University of Pennsylvania.