Find Out What Defines a Recession, Who Determines It, and What It Means for Your Investments
Recessions are known for the pain they inflict, including layoffs and slowing GDP growth. The bad news dominates the headlines, while politicians and the news media debate whether we are in one. Yet, who decides when a recession starts is not Wall Street, the President, or Congress.
Instead, an influential group of economists with the National Bureau of Economic Research (NBER) decides this. The NBER is a non-governmental, nonprofit organization that declares the beginning and end of all US recessions. Their decisions shape everything from economic policy to investor sentiment on Wall Street.
What is a Recession?
Most people assume that a recession is defined as two consecutive quarters of negative GDP growth. These generalized views make it harder to understand these economic events. Let’s be clear about what it is by using the NBER’s standards. It defines an economic recession as,
“A significant decline in economic activity spread across the economy, lasting more than a few months. Several signs of weakness are visible in real GDP, income, unemployment, industrial production, and retail sales.”
This broader definition helps explain when these events could occur.
Who Decides When an Economic Recession in the U.S Begins and Ends?
In the U.S., the NBER’s Business Cycle Dating Committee decides if the conditions match the definition. This panel of economists examines a range of data. The most critical pieces are retail sales, industrial production, unemployment, GDP, and income.
The NBER evaluates the monthly and quarterly figures to determine whether we are in a downturn. They declare downturns retroactively, which means it could be several months until you realize it.
What about Global Recessions?
Global recessions are declared by international organizations such as the World Bank and the International Monetary Fund (IMF). These organizations look at metrics similar to those of the NBER, but for major economies worldwide. They use indicators such as negative GDP growth in these economies to decide if we are in a downturn.
Why Not the President or the Federal Reserve?
A common misconception is that the President or the Federal Reserve (the Fed) has more control over when slowdowns begin. Both play vital parts in managing the economy and policy responses. Yet, neither one has the power to unilaterally declare a U.S. recession.
The President: The President can comment on the economy’s health or offer opinions. His views are seen as political. In other words, what he says about the start of the slowdown and where we are is only his opinion.
The Fed: The Fed controls interest rates, fights inflation, and promotes economic stability. Its actions can stimulate or cool the economy. Yet when a U.S. recession begins, the Fed relies on the NBER for official confirmation.
The Importance of Calling an Economic Recession
The declaration of an economic recession will have impacts across the global economy and financial markets. These effects include
Policy Responses: Governments often rely on data from the NBER, IMF, and World Bank. Their information helps them decide whether to lower interest rates and if stimulus measures are necessary.
Investor Sentiment: The financial markets react quickly once an economic recession is declared. Investors focus on the future and use different models to predict which areas will perform the best.
Business Decisions: Based on the data, companies could decide to delay new investments or cut costs. Their decisions, influenced by the NBER’s declaration, have ripple effects across the economy.
The Bottom Line
Economic recessions are not just talking points in the news media. Instead, these are downturns, with independent and trusted economists calling the shots on their beginnings and endings.
Remember this the next time you hear about a slowdown. It is not the President or the Fed that decides when these events begin. Instead, it is the NBER, with its wealth of data and expertise, that uses a range of models to make the call. These declarations are usually months after the fact. With this knowledge, you can better navigate these uncertainties and prepare for the next recession.