Recession: The Measure of Economic Weakness II

Of our four indicators measuring economic weakness only real manufacturing and trade sales exhibit upside momentum. The other three indicators suggest weakness consistent with a significant slowdown but not a recession. For decision-makers, caution remains the guiding principle as the balance of risk/reward still favors risk at this time.
Recession/Slowdown - Our Four Guideposts

How does the National Bureau of Economic Research (NBER), the official arbiter of U.S. business cycles, determine the beginning and the end of a recession? A trough in the business cycle marks the end of a recession and the beginning of an expansion. The traditional role of the committee is to maintain a monthly chronology so they refer almost exclusively to monthly indicators. As a result of this monthly focus, the committee gives relatively little weight to real GDP, which is only measured quarterly and subject to continuing, large revisions. The broadest monthly macroeconomic indicator is employment. The committee also generally studies another monthly indicator of economy-wide activity, real personal income less transfer payments adjusted for price changes. In addition, the committee refers to two indicators with coverage of the manufacturing sector and the broader sales and distribution of goods: (1) industrial production and (2) the volume of sales of the manufacturing and trade sectors.
Another Look: Using the Hodrick-Prescott Filter Approach

Last month we created “spider charts” for all four indicators to illustrate the recession/slowdown criteria. This month we employ the Hodrick-Prescott filter technique to distinguish the cycle and the trend for each of the four core series. One series, real manufacturing and trade sales, (top graph), suggests an upward trend in recent months and is neutral at this point on the recession outlook.

However, our other three series all suggest a significant slowdown although not quite the declines associated with recessions. Industrial production, illustrated in the middle graph, reveals a slowdown but not quite the weakness seen in 1990-91 or 2001. Real personal income less transfer payments as well as employment both follow this pattern.
Benchmarking the Four Indicators: Clear Slowdown

When we combine our four indicators into a recession composite index (bottom chart) we can see that the slowdown in the economy has been in place since the late Fall. This shift suggests continued caution for decision-makers. It is still too early to call for an economic recovery.

Moreover, the determining factor that will decide the path to recession or just a slowdown will likely come down to the credit restraints now being put in place by Congress and the accompanying risk avoidance evident in the latest Senior Loan Officer Survey. Liquidity provisions made the 1987 and 1998 crisis short. The heightened regulatory impositions of the 1990-1992 period prolonged and deepened that particular recession.



Wachovia Corporation

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