Today, I was reading a piece by John Tammy in Forbes about why the Fed won’t cause a recession. It wasn’t very re-assuring:

[…] governments can’t cause recessions given the more important truth that actual recessions paradoxically signal economic recovery. What governments cause is economic slowdowns born of barriers to production. The difference between the two is Pacific Ocean wide.

So … the government can’t cause a recession—but it can kill the economy. Do you feel any better now?

If that sounds a bit like pedantic word-picking to you, that’s because it is. But we’re here at recession nerd, so let’s consider the author’s point. What, for Tammy, is a recession?

Effects View: An economic cleansing

I’ll quote the article one more time:

during good times some of us develop bad habits […] It’s during recessions that we fix what we were doing wrong.

For Tamny, recessions are part of a healthy business cycle. In boom times, many companies “commit capital less carefully” (i.e. take stupid risks or waste loads of money) because they can: borrowing is cheap.

Recessions reverse that: borrowing money becomes expensive, so you really got to be prudent where and how you spend. Companies which don’t, or which don’t make profits, go under.

This “cleansing” of the economy is what recessions are about—in this “effects” view. A downturn is just a temporary correction that does not have this deep cleaning effect.

Boom times are the party the night before that went a bit too crazy. Recessions are the inevitable hangover the morning after.

Weirdly enough (to me), Tamny then says that the Fed therefore can’t cause recessions. The argument seems to be that the Fed can neither make companies invest foolishly during boom times nor change the way they operate and investment during downturns. This seems to me to forget a few things:

  • we get bubbles (i.e. dumb investments) all over the place once the Fed opens the money hose
  • let’s say we get a massive downturn that would lead to the cleansing Tamny talks about. The Fed can easily prop up companies that ought to change or go under with cheap credit
  • if the Fed makes a downturn bad enough, by making credit expensive enough, and any company relying on cheap money or eternal hopes of growth must go under.
  • one argument is that even if the Fed makes credit expensive, money is global and so cheap money will replace the missing dollars. seems to me that misses both that the USD is the favorite location to park money for safety, currently still the reserve currency that you gotta have to trade, and that central banks all over the globe usually copy what the Fed does.

All that aside, though: the view of recessions as a time when the economy is being cleansed of past excesses is a popular one.

GDP View: A technical recession

And then you have the “two quarters” definition. So if GDP goes down two quarters in a row, then you have what they call a “technical recession”.

What does that mean for the economy? Only that things haven’t looked up for 6 months straight. It doesn’t mean things are terrible. For sure there doesn’t have to be a “cleansing” going on.

In this view, the difference to a normal downturn is the length: if GDP contracts for only 5 months, there is no recession. There are many problems with this definition of a technical recession—but it has it’s uses: for making a quick call if things are in a slump or not.

Behavior View: A demand plunge getting worse and worse

Finally, let’s look at how the NBER, the ECRI and other national institutes define reessions. While they look at a lot of technical indicators—like GDP or unemployment—they aren’t giving you an exact formula how they’re determining if a downturn is a recession. Their goal is to capture the idea of a downturn that is special because it’s getting worse and worse. Here is how the ECRI puts it:

A recession is a self-reinforcing downturn in economic activity [] - in effect a vicious cycle.

The problem is falling demand, and you can read the full ECRI definition here.

In short: I don’t agree necessarily with Tamny’s point—but then again maybe I just didn’t get it. But I do appreciate his view of what a recession is—it’s just not the only one out there.