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Monday, May 20, 2019

Comments On Turning Points And Recessions

Canada: Real GDP and recessions

One of subtle issues with recession analysis is defining when they occur. For the United States, the National Bureau of Economic Research (NBER) has managed to become the authoritative source for recession dating, whereas for other countries, the dating process is less clear. In Canada, the C.D. Howe Institute has created a Business Cycle Council which has a mandate to date recessions: https://www.cdhowe.org/council/business-cycle-council. The chart above shows the post-1990 history of real GDP growth and the recession dates as defined by that committee. There are two declared recessionary periods: March 1990 - April 1992, and October 2008 - May 2009.

From a practical perspective, one might argue that the bar for declaring a recession is too high.
Canada: Unemployment Rate and Recessions

The figure above shows the Canadian unemployment rate and the C.D. Business Cycle Council's recession dates. (Note that this council was formed after the 2008 Financial Crisis, and so the earlier recession dates were based on applying a particular methodology to past data.) The unemployment rate by just over 1% in 2001, in a relatively rapid fashion. Although the downturn was somewhat localised, it certainly felt like a depression for anyone associated with the technology industry.

Chart: Rise in Canadian Unemployment Rate versus 12-month trailing minimum

The chart above shows the rise in unemployment rate versus the trailing minimum value over the past 12 months (including the current month, so the minimum of this time series is zero). We see a big jump in 1992, as well as 2001, that were not classified as recessions (based on continued growth in other economic activity series).

I would argue that the rise in the unemployment rate overshadows the other activity indicators for two sets of reasons.
  1. Normative policy perspective: we should react to a rise in the unemployment rate on the basis of ethics, as well as the cost on society created by unemployment, as well as the long-lasting effects of job loss (referred to as "hysteresis").
  2. Inflation-targeting perspective. In the post-1990 environment, the only plausible candidate for "capacity constraints" in the domestic developed economies revolve around the labour market -- other than in the commodity markets. There is a massive excess of manufacturing and service sector productive capacity, so that growth in output alone is not enough to trigger a plausible inflation risk. (Note that although I view NAIRU to be a joke of a concept, we presumably have to accept that labour market "tightening" will eventually pose wage inflation risks. As we have discovered repeatedly since the 1990s, an unemployment rate that is drifting lower tells us little about inflation risks, but a rapid rise probably is telling us something.) 

Canadian Target Interest Rate and Recessions

My comments above on the importance of the rise in the unemployment rate are not purely my opinions: the Bank of Canada reacted to the weakness in the labour market (chart above). From a bond market participant's perspective, the drop in the target rate from 5.75% in January 2001 to 2% in 2002 is what you are paid to forecast, not what the C.D. Howe Business Cycle Council thinks.

Figure: OECD LEI Turning Points and Real GDP (Canada)

However, it is possible to get a definition that is perhaps too jumpy. The figure above shows Canadian real GDP, and the "turning points" defined by the OECD leading economic indicator. (URL: http://www.oecd.org/sdd/leading-indicators/oecdcompositeleadingindicatorsreferenceturningpointsandcomponentseries.htm.) The OECD has these indicators for most (if not all) of the countries in their data coverage universe.

The shaded regions show where the OECD leading economic indicator dropped from a local peak to a local trough. It does align very well with the acceleration and deceleration of real GDP growth, so these indicators could be useful for some purposes. (For example, financial markets might be sensitive to such acceleration.)

However, the "negative turning points" appear to be too numerous to be taken as a definition of a recession. For example, we saw very little in the way of a rise in the unemployment rate during two of the episodes after the Financial Crisis, and only about 0.5% in the third (below).
Chart: Turning Points and Unemployment Rise

Concluding Remarks

As the Canadian experience shows, deciding which episodes qualify as "recessions" can be debated. The safest course of action is to make it clear what definition you are using, and apply it consistently across regions.

(c) Brian Romanchuk 2019

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