Markets Are Obsessed With A Term No One Can Define

The US is either in a recession already or headed into one soon. Now if only we knew what a “recession” is. Or was. Or isn’t. Or wasn’t.

Last week, Bill Ackman took the lead in redefining the term. “Two quarters of negative GDP growth does not… seem to be a reasonable definition during a period with high inflation,” he said, adding that the economy has “a supply, not a demand problem [which] does not seem like a set up for a true economic recession regardless of the favored definition.”

With one quarterly contraction already on the books and many real-time trackers of current quarter growth flashing yellow for a second quarterly decline in real output, I’ve repeatedly suggested the only way for the US economy to avoid a recession is for analysts, economists and, importantly, the White House, to redefine the word.

Those efforts are now in full swing. “What is a ‘recession,’ anyway?” TD’s Oscar Munoz asked, in a recent note, on the way to citing the NBER’s Business Cycle Dating Committee which, you’re reminded, affords market participants (and itself) quite a bit of definitional latitude:

The NBER’s traditional definition of a recession is that it is a significant decline in economic activity that is spread across the economy and that lasts more than a few months. The committee’s view is that while each of the three criteria — depth, diffusion and duration –needs to be met individually to some degree, extreme conditions revealed by one criterion may partially offset weaker indications from another. For example, in the case of the February 2020 peak in economic activity, we concluded that the drop in activity had been so great and so widely diffused throughout the economy that the downturn should be classified as a recession even if it proved to be quite brief. The committee subsequently determined that the trough occurred two months after the peak, in April 2020.

The NBER is an arbiter of a subjective phenomenon which passes judgment with the benefit of hindsight. You’d be forgiven for suggesting that’s redundant to the point of absurdity. If you’re the arbiter (the “Decider” as George W. Bush might put it), you’re unique in that you actually don’t benefit from hindsight, which is neither help nor hinderance. If you, and only you, have the final word, and what’s in question isn’t an objective fact of nature, but rather some subjective determination, then what use have you for hindsight?

In the case of economic downturns, the answer is that the arbiter shouldn’t declare a recession too hastily because plenty of other people are capable of measuring economic activity and might come to different conclusions in the presence of sufficient ambiguity. Technically, as the arbiter, your determination will be the final word, but if the community of people who care about such things start to suspect you’re not a very good judge, they might collectively decide you’re no longer the Decider.

The problem with all of this is obvious. Or at least it is to me. In the event the economy i) becomes exceptionally volatile, leading to highly compressed cycles and unpredictable oscillations in business spending and corporate profits, or, ii) flatlines in the presence of constrained monetary policy and political gridlock, there could be considerable disagreement around whether there is or isn’t a recession.

The NBER’s “traditional definition” isn’t really a “definition” at all. If we truly are exiting the era of “smoothed out” business cycles, “significant declines in economic activity” could become commonplace. As could significant increases. You could argue that “more than a few months” offers something in the way of guidance. But the NBER broke with that convention in 2020. And the language they employ leaves the door open to doing so again whenever “one criterion” out of three is deemed “extreme.” But they don’t define “extreme.”

The Committee looks at a specific set of indicators, all of which are publicly trackable, but by its own admission has “no fixed rule about what measures contribute information to the process or how they are weighted in decisions.”

As for the two-quarter rule of thumb, they simply don’t use it. “Real GDP could decline by relatively small amounts in two consecutive quarters without warranting the determination that a peak had occurred,” the Committee notes.

Nothing found on the official FAQ page is particularly problematic as long as the economy remains at least a semblance of well-behaved. If, however, the term “cycle” starts to look like a misnomer, or, alternatively, the economy enters a long period characterized by successive small contractions interrupted occasionally by one- or two-quarter expansions, it’s entirely possible that many observers would see one never-ending recession while others would be reluctant to countenance the notion that “growth” as we know it has effectively stopped.

It may be time to at least ponder the prospect of a binary outcome, where one path leads to short, volatile cycles and the other to perpetual stagnation — not “secular stagnation” as such, but a “no-growth” future that never resolves.** In either case, the situation wouldn’t be amenable to consensus around a nebulous concept like “recession.”

Stripped of pretensions to scientific rigor, “recession” is an amorphous term that denotes an arbitrary threshold indicative of slower growth. Arbitrary thresholds are problematic enough when we know what they are. We chafe, for example, at the notion that stocks aren’t in a “bear market” if an equity benchmark closes 19.5% from the highs.

With recessions, we don’t even know what the threshold is. This entire charade is complicated by the fact that measuring growth is itself an imprecise exercise that entails so many assumptions, subjective judgments, adjustments to offset distortions and innumerable methodological choices, as to render the final calculation mostly meaningless anyway.

Over the years, I’ve come to regard almost all things I once held dear to be mostly devoid of meaning. Documenting that evolution publicly, in these pages, stuck me with a very large apology tab payable to the economics community. I’ll also need to make amends with statisticians. Because the truth is, it’s impossible to calculate an aggregate measure of economic output for a country of 330 million people. The fact that we try is a testament to ambition, hubris or stupidity. I’d note that in many cases, those three things are inseparable.

**Addendum: A literal “no-growth” future is the end game. There’s virtually no chance that humans will exist long enough to develop the kinds of technological innovations necessary to coax ever more growth out of a finite world. Eventually, once all the resources are exploited, and all emerging and frontier markets are “developed,” that’s it. That’s the end of growth. The only way around that is accelerated innovation and enhanced productivity. We’re advancing rapidly as a species, but not rapidly enough. This (all of it) will end before we crack the proverbial code.