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EXPLAINER: How do we all know when a recession has begun?

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WASHINGTON — The U.S. financial system has contracted for 2 straight quarters, intensifying fears that the nation is on the cusp of a recession — if not already in a single — barely two years after the pandemic recession formally ended.

Six months of contraction is a long-held casual definition of a recession. Yet nothing is easy within the post-pandemic financial system. Its course has confounded Federal Reserve policymakers and plenty of non-public economists since development screeched to a halt in March 2020 as COVID-19 struck and 20 million Americans had been immediately thrown out of labor.

Even because the financial system shrank over the primary half of this yr, employers added 2.7 million jobs — greater than in most complete years earlier than the pandemic struck. And the unemployment fee has sunk to three.6%, close to a half-century low. Robust hiring and exceedingly low unemployment aren’t in keeping with a recession.

While most economists — and Fed Chair Jerome Powell — have stated they do not assume the financial system is in recession, many more and more count on an financial downturn to start later this yr or subsequent.

Either method, with inflation raging at its highest degree in 4 a long time, Americans’ buying energy is eroding. The ache is being felt disproportionately by lower-income and Black and Hispanic households, lots of whom are struggling to pay for higher-cost necessities like meals, gasoline and hire. Compounding these pressures, the Fed is jacking up rates of interest on the quickest tempo for the reason that early Eighties, thereby magnifying borrowing prices for houses and vehicles and bank card purchases.

As a end result, no matter whether or not a recession has formally begun, Americans have more and more soured on the financial system,

So how, precisely, do we all know when an financial system is in recession? Here are some solutions to such questions:

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WHO DECIDES WHEN A RECESSION HAS STARTED?

Recessions are formally declared by the obscure-sounding National Bureau of Economic Research, a gaggle of economists whose Business Cycle Dating Committee defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”

The committee considers tendencies in hiring as a key measure in figuring out recessions. It additionally assesses many different knowledge factors, together with gauges of revenue, employment, inflation-adjusted spending, retail gross sales and manufacturing facility output. It places heavy weight on jobs and a gauge of inflation-adjusted revenue that excludes authorities help funds equivalent to Social Security.

Yet the NBER sometimes would not declare a recession till nicely after one has begun, typically for as much as a yr. Economists take into account a half-point rise within the unemployment fee, averaged over a number of months, as essentially the most traditionally dependable signal of a downturn.

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DO TWO STRAIGHT QUARTERS OF ECONOMIC CONTRACTION EQUAL A RECESSION?

That’s a standard rule of thumb, nevertheless it is not an official definition.

Still, previously, it has been a helpful measure. Michael Strain, an economist on the right-leaning American Enterprise Institute, notes that in every of the previous 10 instances that the financial system shrank for 2 consecutive quarters, a recession has resulted.

Still, even Strain is not positive we’re in recession now. Like many economists, he notes that the underlying drivers of the financial system — shopper spending, enterprise funding, house purchases — all grew within the first quarter.

Overall gross home product — the broadest measure of the nation’s output — declined at a 1.6% annual fee from January via March due to one-off elements, together with a pointy soar in imports and a post-holiday season drop in companies’ inventories. Many economists count on that when GDP is revised later this yr, the primary quarter could even transform optimistic.

“The basic story is that the economy is growing but still slowing, and that slowdown really accelerated in the second quarter,” Strain said.

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DON’T A LOT OF PEOPLE THINK A RECESSION IS COMING?

Yes, because many people now feel more financially burdened. With wage gains trailing inflation for most people, higher prices for such essentials as gas, food, and rent have eroded Americans’ spending power,

This week, Walmart reported that higher gas and food costs have forced its shoppers to reduce their purchases of discretionary spending such as new clothing, a clear sign that consumer spending, a key driver of the economy, is weakening. The nation’s largest retailer, Walmart reduced its profit outlook and said it will have to discount more items like furniture and electronics.

And the Fed’s rate hikes have caused average mortgage rates to double from a year ago, to 5.5%, causing a sharp fall in home sales and construction.

Higher rates will also likely weigh on businesses’ willingness to invest in new buildings, machinery and other equipment. If companies reduce spending and investment, they’ll also start to slow hiring. Rising caution among companies about spending freely could lead eventually to layoffs. If the economy were to lose jobs and the public were to grow more fearful, consumers would further reduce spending.

The Fed’s rapid rate hikes have raised the likelihood of recession in the next two years to nearly 50%, Goldman Sachs economists have said. And Bank of America economists now forecast a “mild” recession later this yr, whereas Deutsche Bank expects a recession early subsequent yr.

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WHAT ARE SOME SIGNS OF AN IMPENDING RECESSION?

The clearest signal that a recession is under way, economists say, would be a steady rise in job losses and a surge in unemployment. In the past, an increase in the unemployment rate of three-tenths of a percentage point, on average over the previous three months, has meant that a recession will soon follow.

Many economists monitor the number of people who seek unemployment benefits each week, which indicates whether layoffs are worsening. Weekly applications for jobless aid, averaged over the past four weeks, have risen for eight straight weeks to nearly 250,000, the highest level since last November. While that is a potentially concerning sign, it is still a low level historically.

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ANY OTHER SIGNALS TO WATCH FOR?

Many economists also monitor changes in the interest payments, or yields, on different bonds for a recession signal known as an “inverted yield curve.” This occurs when the yield on the 10-year Treasury falls below the yield on a short-term Treasury, such as the 3-month T-bill. That is unusual. Normally, longer-term bonds pay investors a richer yield in exchange for tying up their money for a longer period.

Inverted yield curves generally mean that investors foresee a recession that will compel the Fed to slash rates. Inverted curves often predate recessions. Still, it can take 18 to 24 months for a downturn to arrive after the yield curve inverts.

For the past two weeks, the yield on the two-year Treasury has exceeded the 10-year yield, suggesting that markets expect a recession soon. Many analysts say, though, that comparing the 3-month yield to the 10-year has a better recession-forecasting track record. Those rates are not inverted now.

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WILL THE FED KEEP RAISING RATES EVEN AS THE ECONOMY SLOWS?

The economy’s flashing signals — slowing growth with strong hiring — have put the Fed in a tough spot. Chair Jerome Powell is aiming for a “soft landing,” in which the economy weakens enough to slow hiring and wage growth without causing a recession and brings inflation back to the Fed’s 2% target.

But Powell has acknowledged that such an outcome has grown more difficult to achieve. Russia’s invasion of Ukraine and China’s COVID-19 lockdowns have driven up prices for energy food, and many manufactured parts in the U.S.

Powell has also indicated that if necessary, the Fed will keep raising rates even amid a weak economy if that’s what’s needed to tame inflation.

“Is there a risk that we would go too far?” Powell asked last month. “Certainly there’s a risk, but I wouldn’t agree that’s the biggest risk to the economy. The biggest mistake to make…would be to fail to restore price stability.”


EXPLAINER: How do we all know when a recession has begun?.
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