I L /723 -- 80203 PSEEEW Washington University K V?/F’ R 55'» I7: &.f'‘%:r:' 1“ i S ." A-45$ Kw "‘£Y! fig‘ '.’,-'1TF‘.-n’{'(j‘..;"=:,\{"(“¢"-""7535" '1 A A \. Ll V‘; £:“L'ii.'~-Y: ,_,,- J“ 2 Mini Brlef “Owes A L‘Bs‘?:.Me2:s**£r ET? ..:'»’-:;.s- 5 M3 CONGRESSIONAL E . RESEARCH SERVICE ;'3ne:;§§ E a tIIIt1fiflfi@E1m@fi[;ia§]@i;@‘g@@HfiiLililimml} RECESSION: CHARACTERISTICS OF AN ECONOMIC DOWNTURN MINI BRIEF NUMBER Mseozoa AUTHOR: Barry Molefsky Economics DiVi~SiOI1 THE LIBRARY or CONGRESS CONGRESSIONAL RESEARCH SERVICE MAJOR ISSUES SYSTEM DATE ORIGINATED 01/30/so ~ DATE UPDATED 03/26/82 FOR ADDITIONAL INFORMATION CALL 287-5700 0329 iCRS- l ‘$380203 HPDHTE-O3/26/B2 ISSUE'DEFINITION In January l982, the National Bureau of Economic-aesearch iannounced that it had determined that July l982 marked a business cycle peak and the onset of the eighth recession since the end of World War. II. ‘This. is .alsos the second recession in as many years and follows one of the shortest expansions on record. The purpose of this mini brief is to explain what a recession is and review the characteristics Of the recessions experienced by the ‘United States since the end of World War II. BACKGROUND Economic activity in the; United States is subject to rcyclical fluctuations- Twenty-nine complete business cycles have been observed since the l850s- A definition of the business cycle has been formulated by the National Bureau of Economic Research (NBER), ‘a private, non-profit, non-partisan organization: A Business cycles are a type of fluctuation found in the .aggregate economic activity of nations that organize their work mainly in business enterprises: .a cycle consists of expansions occurring at about the same time in many «economic activities, followed by similarly general recessions, contractions, and revivals which merge into the expansion phase of the next cycle; this'sequence of changes is recurrent.but not periodic; in duration business cycles vary from more than one year to ten or twelve years; they are not divisible into shorter cycles of similar character with amplitudes approximating their own. Under this definition a cycle contains four distinct phases: lexpansion, when measures of economic activity successively reach new highs; lrecession, when the economy remains at a high level for a short period of time; contraction, when the economy recedes from its high level for a sustained period of time; and revival, when the “economy begins to rise again and reaches its previous peak. In common usage however, the distinction between the recession and contraction phases of the business cycle has been lost and the two terms are used synonymously. Economic downturns can be characterized as either recessions or depressions depending on their depth and duration. According to Dr. Arthur Burns, a former chairman of the Federal Reserve System, a recession is "a moderate contraction of economic activity that lasts in the neighborhood of a year." A depression, notes Dr. Burns, "refers to a severe contraction or to one which, while moderate, lasts distinctly longer than a year." Imbalances in economic activity that develop during the expansion phase of the business cycle are generally responsible for the onset of a contraction. The following example illustrates this process. . During an expansion increases in sales and profits lead to the expectation that such increases will continue. As the expansion progresses and production approaches pcapacity levels, available resources shrink, prices begin to rise, and deliveries are delayed. ‘In this environment firms begin to ihoard materials “CR8-= 2 318.8 02 03 U1=.nA1rE- 03 /:2 6 /:82 and labor, and begin to over order supplies with the intention of icancelling excess orders once materials are received. Inventories at the manufacturing, wholesale, and retail levels begin to ,accumulate. with both prices .and interest rates rising in response to.an increased demand for money, the -cost of financing inventories increases. Higher financing costs along with higher labor costs lead to an erosion of profits- rBusiness optimism begins to wane and-expectations of future sales and earnings become pessimistic- Attempts to reduce inventories include curtailed levels of production and jcutting prices (or offering discounts from listed prices). Such .actions tproduce higher unemployment, lower incomes and profits, and a sgeneral reduction din aggregate economic activity. 1 i i This sequence of events will not necessarily occur in all sectors of the economy simultaneously. It may occur in one industry and spread to others- For example, if automobile inventories become too large, automakers will shut down assembly lines. This in turn will trigger production cutbacks by auto suppliers such as steel, aluminum, glass, and tires. Supplierst to those industries will then be forced to cut their output. In this fashion production cutbacks ripple through the economy. In addition, of course, .the workers who are laid off will reduce their spending so. that retail outletsv and consumer goods manufacturers will experience declines in sales and will, in turn, increase the number of layoffs in these sectors. l Imbalances in foreign trade, capital investment, tconsumer spending, .and government spending can also lead to a contraction. Events outside the .economic system, such as a drought, smay also~ cause economic tdownturns. Actions by the Federal Government, such as reducing spending _and/or raising taxes, or restricting the availability of credit, can also produce a falloff in aggregate economic activity. . Determining when the economy has entered a recession is done by the .NBER; its findings are accepted as definitive by economists and the United ~States Government. Contrary to press reports, two consecutive quarters of declining gross national product (GNP) by itself does not constitute a recession. GNP declined in only one quarter during the 1980 recession. when making its determination the NBER examines a large number of economic indicators, such as the average workweek, new orders for durable goods, commodity prices, and industrial production. If the data indicate a decline in economic activity of sufficient depth, duration, and diffusion, then the period being surveyed will be labeled a recession. Diffusion refers to how widespread the downturn is; the contraction must be evident in many of the indicators examined. Given the lack of precision in the NBER's definition of the business cycle and the fact that the characteristics of each cycle are unique, considerable judgement must be exercised in fixing recession dates. In fact, it is not unusual for those dates to be revised. For example, an extensive review .of business cycle indicators undertaken in 1975 resulted in the redatingi of three contractions. Of the 29 U.S. business cycles since 1854, identified and dated by the NBER, five are associated with wars. The average length of the 24 peacetime cycles has been about 4 years. Particular cycles have been as short as 17 months and as long as 8 1/2 years. Prior to world War II the cycles were, on average, about evenly divided between expansions and contractions. Since 1945, however, expansions have lengthened to about 3 years, while contractions have shortened to roughly 1 year. Over the past 35 years there have been 7 recessions. The table below ;cns- 3 -«B50203 UPDATE-03/26/82 presents a thronology of the postwar slumps and indicates each. While there are similarities among the recessions, no two.are -exactly .alike. of the 7 recessions, the l969~70 downturn appears to have ,been the mildest while the 1973-75 experience was clearly the harshest- With the exception of the l973-75 contraction, real GNP surpassed its previous ;peak after 4 quarters. Peaks in real GNP do not necessarily coincide with peaks in the business cycle; in 3 of the recessions (l953—54, l960, 1969-70) the high point in real GNP occurred one quarter ‘before the cyclical peak as determined by the NBER- iRecession‘Profi1es ,Business Cycle Reference Dates Percentage Change a/ »Peak Unem- Duration Real vployment Peak Trough (months) GNP gggl Employment Rate (%) Nov. 1948 Oct. 1949 ll -1.4. -2-1 -2.0 7.9 5 July 1953 May 1954 n/ 10 -2-5 0-2 -2.4 5.11 Aug. 1957 Apr. 1958 8 -2.7 2.1 -2-1 7.4 Apr. 1950 Feb. 1951 10 -0.1 0.9 -0.5 7.1 Dec. 1959 Nov. 1970 b/ 11 -0.8 5-0 -0.3 5.1 Nov. 1973 inar. 1975 15 -4.8 14.7 -1.5 9.o Jan. 1950, -2-0 5.3 -0.7 ~7-5 July 19ao 5 a/ This is the change between the business cycle reference dates; the peaks and troughs of individual indicators may not coincide with these dates. 6 b/ War related contractions (Korea and Vietnam). Sources: ‘National Bureau of Economic Research, Inc.; Ugs. Department of Commerce, Bureau of Economic Analysis; and U.S. Department of Labor, Bureau of Labor Statistics. The peak unemployment rates reached during each recession range from 6.1% in 1953-54 and 1969-70, to 9.0% in 1973-75. These high unemployment rates were not usually reached until well into the downturn. There does not appear to be any systematic relationship between the magnitude of the decline in real GNP and the peak unemployment rate. For example, real GNP experienced a greater decline during the 1953-54 downturn than in the 1960 recession, yet the unemployment rate was higher during the latter period. The rates of inflation during each downturn have in general each contraction. But again, the extent of the decline varies from period to period. Moreover, the gains against inflation were apparentlyg short-lived. At each business cycle peak since 1960 the inflation rate has been higher than at the previous peak. 1 1 eased during sluggish economic activity during 1979 prompted many analysts to, conclude that a recession was underway. It was not until mid-1980 that the NBER's Committee on Business Cycle Dating determined that a business cycle peak had been reached in January 1980. Downturns in industrial production, retail sales, and hours worked were cited by the Committee as factors pointing to the January 1980 date. It turned out that by the time the NBER» had tthe severity Of‘ CRS- 4 ‘$380203 MPDATE~D3/26/82 determined that the«economy was in recession, the recession was nearly over- In July l98l the WBER established July 1980 as the end of the recession- =The l980 recession was the briefest in U.s. history- i In the 3 quarters following the recession the-economy expanded at a crisp rate. But, in the 2nd quarter, l98l, high interest rates began to dampen ieconomic:activity. Real GNP fell-atsan-annual rate of 1-6%. This decline was concentrated in the credit sensitive sectors of the economy, particularly .automobiles and housing. Data for the 3rd quarter suggested that other sectors of the economy were.beginning to .meaken- Figures for tindustrial production were particularly disturbing as every major market group, with the notable«exception of defense. and space iequipment, registered a decline. Unemployment began to rise sharply, reaching 8.8% of the labor forced in December l98l. In the 4th .quarter of l98l, economic .activity fell- precipitously with real GNP declining at a 5.2% annual rate. On Jan. 7, 1982 the NBER determined that July 1981 marked a business cycle peak and the onset of a recession. This date was based on the behavior of industrial production and unemployment. The downturn has continued into the early months of 1982. but there is growing sentiment that the recession is near its end- it The recovery from the January-July 1980 recession was only 12 months; "one of the shortest ever recorded. Given the brief. duration of »the l980 recession and the 1980-81 recovery, some analyst have raised the possibility that the NBER has erred in its business cycle chronology. Irwin Kellner, senior vice president and economist at Manufacturers Hanover Trust Company wrote in a July 1981 reporty "To many consumers and businessmen in the ‘real world,’ the recession really got under way in 1979 -+.and is still withp us." If Kellner*s chronology is correct, the current contraction would rank as the longest of the post war period. dFor a discussion of the projected course of economic activity over the next four quarters see mini brief. 79230, The Economic Outlook: A Comparison of Short-Term Forecasts. .