How Do We Know if the United States Headed for a Recession? - ToughNickel - Money
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How Do We Know if the United States Headed for a Recession?

Ian is a geopolitical forecaster and obtained his MBA from Villanova University.

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What Is A Recession?

First of all, it's important to understand that the answer to "what is a recession" is somewhat ambiguous. Let's take a look at it to understand more.

This is the official definition and it comes from the National Bureau of Economic Research. But what counts as a significant decline? How long is a few months?

The economy is a big and complicated machine, and there are several parts that economists look at to say whether a recession is coming.

The "Simple" Definition

There's a simple and very objective definition that is usually taken to indicate we're in a recession: two straight quarters of declines in real gross domestic product.

This is much easier to measure. It's a definite time period (six months in a row) and a well known quantity (real gross domestic product, or real GDP). If it's been a while since your last economics class, GDP is the total value of goods and services produced in a country. It's a very broad measure of how well a country's economy is doing, and it accounts for a lot of inputs, which is why it's useful.

But there are problems. In particular, it's not really helpful at indicating if a recession is coming. That's because it's only quarterly, and the initial numbers are frequently adjusted anyway. So there are indicators which are updated monthly and are therefore much more practical to use.

Let's go into the indicators, or inputs, in a little more depth.

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What's Underneath The Hood - Recession Indicators

There are four core indicators that economists watch to try and figure out if a recession is looming. They're more useful to watch than the GDP because they're updated monthly, and they're not subject to the same magnitude of revision.

  1. Real income. When real income declines, that reduces consumer purchases and demand.
  2. Employment. The monthly jobs report is the broadest monthly indicator used by economists.
  3. The manufacturing sector, as detailed by the Federal Reserve Board.
  4. Manufacturing and wholesale-retail sales provided by the Bureau of Economic Analysis of the Commerce Department .

These figures might have some adjustment calculations applied to account for things like inflation.

Finally, while the NBER does review monthly estimates of GDP, this is given much less weight than the other four indicators.

But Wait - Some Other Indicators

All of this gets pretty technical. It's also not an exact science - because the economy is so complex, there's no exact formula that ties together all these indicators. So no one of these indicators by itself will predict a recession.

But over the last century, people have discovered there are other signs which are so big that they can be glaring warnings. There are a lot of reasons why economists don't rely on these, but it's still fair to say that if certain events occur then it's often been followed by a recession.

The most popular one (partly because it's so good at predicting recessions) is when long term bonds are giving a lower interest rate than short term bonds. It's called an inverted yield curve, and you can click on that link to read much more about what it means.

Consumer and business sentiment is another well-known indicator. This means that consumers and business owners are becoming more pessimistic about how well the economy is doing.

Finally, a decline in global growth can be an indicator of a potential U.S. recession. The world's economies are so intertwined that it's impossible to separate the effects of economic problems in different countries. While the United States is a very powerful economy, it simply isn't possible in today's global economy to be insulated from the rest of the world.

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Why It's Important

So far, all these indicators and warning signs sound like they're really only meaningful to economists, big business, and very wealthy investors. What does a recession actually mean to individuals?

  • Rising unemployment. You're particularly at risk if you don't have a strong skill set, didn't go to college, or are just starting out in the job market.
  • Anti-competitive mergers. These are much more prevalent during a recession, and the results are more job losses as well as lower wages.
  • Social impact. Lower wages, rising unemployment, smaller businesses failing - all these are very stressful and can lead to divorce, mental health problems, and many other social problems.

Yes or No - Will There Be A Recession

It should be clear that this is really difficult to predict. Most opinions right now are saying probably not. Although there are many issues and worrying signals, the economy is generally viewed as being on a solid footing.

But there's a lot that could go wrong. Although President Trump famously said, "trade wars are easy to win", the reality is much more complicated. We're seeing a lot of big problems which won't be easy to fix, such as drastic losses for farmers. Other countries also have their own economic risks and threats, and a big downturn in the global economy could ripple through to the U.S. economy.

There's also a very real possibility that people talking about recession could be the deciding factor. If there's enough concern and gloom in the air, it makes investors more nervous, leading to more cautious trading and investment patterns - and that can tip over to a recession.

And If So, When?

The biggest warning sign is the inverted yield curve I mentioned earlier. It doesn't mean a recession is inevitable, but it definitely has people worried. But what's the time frame?

Historically, if an inverted yield curve does precede a recession, it's taken about 18 months to two years from the warning signal until the determination is made that we're in a recession.

That's the answer. There's no exact formula, and there are plenty of reasons to feel confident - but let's catch up in 2021 and see how it's all worked out.

This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.

Comments

Carolyn Fields from South Dakota, USA on September 19, 2019:

"There's also a very real possibility that people talking about recession could be the deciding factor."

Exactly!

Ken Burgess from Florida on August 29, 2019:

Yes the system we have in place, ever since creating a central bank and getting off the gold standard, ensures that we will continue to have recessions so long as the current economic model holds.

How bad will this next one will be is impossible to judge. China is a major factor, and they have been cheating at the game a long time, how their economic woes effect the rest of the world could be dramatic... and this is not something we have ever dealt with before. America has always been able to manufacture whatever it needed, and has always been able to lead the world in productivity... this is not the case today.

We also have technological advancements that are moving at breakneck speed, and this too, will be changing the global economic landscape and making more and more jobs obsolete. Along with things like Bitcoin, cashless transactions, internet purchasing, etc.

Lastly we have a growing population, an explosion of people... which is the largest problem of all... in 1960 we had only 3 Billion people on the planet... 60 years later we are headed to 9 Billion. That is an insane growth rate, and at the rate we are going we will deplete this planet of all the necessary resources to sustain life before we hit 2060.

Duncan Mutokaa From Kenya on August 28, 2019:

Very very Educative and Important,i enjoy reading it may God bless you as you continue giving us solutions to now avery big problem that we are facing called Economy.

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