An austere Christmas is on the cards – but don’t say recession

Economists have a terrible track record when it comes to predicting recessions.

By Luke Hartigan

The rapid increase in interest rates over the past year and a half is causing many consumers to feel less than joyous this festive season.

Spending in the lead-up to Christmas is likely to remain subdued, with consumers more budget-conscious than in previous years. The muted outlook for consumption has got some economists and media outlets predicting a possible recession in 2024.

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So, what is a recession and how likely is it Australia will see one next year?

What is a recession, anyway?

The National Bureau of Economic Research (a private research organisation widely seen as the authority for determining recessions in the US) defines recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”

But it is not all just about weak consumption expenditure (people spending a bit less money than usual). In an open economy like Australia, a decline in consumption could just mean a decline in imports. In other words, weak consumption doesn’t necessarily mean we are producing less goods and services locally.

The Reserve Bank of Australia says a recession is often defined as “a sustained period of weak or negative growth.”

But what do we mean by “sustained”? The media usually takes this to mean at least two consecutive quarters of negative growth in economic activity, typically measured by Gross Domestic Product (GDP).

However, the National Bureau of Economic Research does not use a two-quarter rule. And it looks at more than just domestic production. It examines a variety of different measures of economic activity – such as conditions in the labour market and industrial production – when making its decision about whether a recession has occurred or not.

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Currently, there seems to be an obsession with finding some measure that will indicate a recession. The latest candidate, popular among some observers and media outlets, is a “per capita GDP recession”.

This means a fall in GDP per person. That’s an easier set of criteria to meet, so if you go by this definition, a recession is more likely.

Other economists and observers shy away from focusing on economic growth, saying the change in the unemployment rate is a better measure. These people believe a higher unemployment rate provides a better sign a recession has occurred.

The problem is, however, there can be other factors that weaken the link between the labour market and economic activity. Institutional changes to the labour market are one example. The decline in activity in 2008–2009, for instance, showed up as a decline in hours worked rather than an increase in unemployment, something that would not have occurred previously.

Even just using the “technical” definition (the two-quarter rule) of a recession has its problems too. This is because of the issue of data revisions to measures of economic activity such as GDP.

The Australian Bureau of Statistics frequently revises historical values of GDP as new data become available. As a result, a negative quarterly growth outcome in one period can be revised away by the bureau in a subsequent period.

Take any recession warnings with a grain of salt

In the past, from about the 1960s to the 1980s, recessions were more frequent in Australia. But they are less likely now. This is partly because the frequency and volatility of shocks has declined since the mid-1980s.

A series of economic reforms that occurred in the 1980s and 1990s, such as floating the dollar and opening the economy up to greater competition, has also helped reduce the risk of recession. These changes have made Australia more robust to shocks.

We should be sceptical of anyone claiming a recession is just around the corner. Economists have a terrible track record when it comes to predicting recessions.

To forecast a recession, we need to be able to predict “turning points” – periods when economic activity goes from positive growth to negative growth or vice versa. This requires us to predict future shocks, like the outbreak of COVID-19, which is hard to do consistently.

There will always be some probability of a recession in Australia when a very large shock hits us. But our ability to successfully predict when one will occur is poor.

Any prediction Australia is on the cusp of recession should be taken with a grain of salt.

Luke Hartigan, Lecturer in Economics, University of Sydney

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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