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What Is a "Recession"?

The Economist's Economics Focus:

Economics focus: THERE has been a nasty outbreak of R-worditis. Newspapers are full of stories about which of the big economies will be first to dip into recession as a result of the credit crunch. The answer depends largely on what you mean by “recession”.... [T]he standard definition of recession needs rethinking.

In the second quarter of this year, America’s GDP rose at a surprisingly robust annualised rate of 3.3%, while output in the euro area and Japan fell, and Britain’s was flat. Many economists reckon that both Japan and the euro area could see a second quarter of decline in the three months to September. This, according to a widely used rule of thumb, would put them in recession, a fate which America has so far avoided. But on measures other than GDP, America has been the economic laggard....

On GDP growth, America has outperformed Europe and Japan. Unemployment, however, tells a very different tale. America’s jobless rate hit 6.1% in August, up from 4.7% a year earlier, and within spitting distance of its peak of 6.3% during the previous recession.... Another yardstick, GDP per head, takes account of the fact that America’s population is rising rapidly, whereas Japan’s has started to shrink. Since the third quarter of 2007 America’s average income per person has barely increased; Japan’s has enjoyed the biggest gain....

[T]here is good reason to believe that America’s recent growth will be revised down. An alternative measure, gross domestic income (GDI), should, in theory, be identical to GDP. Yet real GDI has risen by a mere 0.1% since the third quarter of 2007.... A study by economists at the Federal Reserve found that GDI is often more reliable than GDP in spotting the start of a recession....

[I]t makes more sense to define a recession as a period when growth falls significantly below its potential rate... potential growth rates are devilishly hard to measure.... One solution is to pay much more attention to unemployment numbers.... A rise in unemployment is a good signal that growth has fallen below potential. Better still, it matches the definition of recession that ordinary people use. During the past half-century, whenever America’s unemployment rate has risen by half a percentage point or more the NBER has later (often much later) declared it a recession....

As the old joke goes: when your neighbour loses his job, it is called an economic slowdown. When you lose your job, it is a recession. But when an economist loses his job, it becomes a depression. Economists who ignore the recent rise in unemployment deserve to lose their jobs.

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