What is a recession

Thu, 03 Sep 2015  |  

Below is an extract from my book, Myth Busting Economics.  It is a brief analysis of the definition of recession and rubbishes the notion of two consecutive quarters of negative GDP growth as a ‘techincal’ recession. 

Oh, and if you want to buy my book, here is the link:
https://www.booktopia.com.au/myth-busting-economics-stephen-koukoulas/prod9780730321958.html 

What is a recession?

Conventionally, an economic recession is indicated by two consecutive quarters in which real GDP falls. The reality, however, at least from a business perspective, suggests this definition is somewhat artificial and, frankly, a little silly.

‘Two negative quarters of GDP growth’ takes no account of context — what happens over a slightly longer time frame, or the country in question.

Let me explain it this way.

Think of Australia and let’s assume we have the following quarterly real GDP growth rates:

▪ Quarter 1: −0.5 per cent
▪ Quarter 2: +0.2 per cent
▪ Quarter 3: −0.8 per cent
▪ Quarter 4: +0.3 per cent.

According to the textbook or conventional definition, there is no recession, because in this illustration there have not been two consecutive quarters in which GDP has fallen. But over the course of the four quarters that make up this particular year, GDP has fallen 0.8 per cent. If this occurred in Australia, the unemployment rate would be around two percentage points higher, businesses would be failing and plainly it would be a recession. 
Of course, much will also depend on the country you are trying to judge. Take China, for example. It’s potential rate of annual GDP growth is widely estimated to be around 7 per cent. That means China’s GDP can expand by 7 per cent before there are problems with inflation, capacity utilisation and potential imbalances in the broader economy.

Let’s make an assumption that in a particular year China’s GDP grew by 4 per cent, or about 1 per cent per quarter. This would be quite catastrophic for the economy. Its banking sector would be in turmoil, deflation risks would abound and for all intents and purposes the country would be in recession. It would simply be growing too slowly.

So, the best definition of recession?

It is a tough call to make, but it needs to take account of the extent to which a country’s growth drops below its long-run potential, the labour market deteriorates (the unemployment rate rises) and inflation falls below the central bank target.

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