Financial Perspectives – Summer 2008

Recession: What’s in a Name?

One way or another, most U.S. consumers – some more than others – have felt the impact of the credit crunch, the subprime crisis, the housing slump and soaring gas prices.

With no definitive knowledge of what to expect, consumers, economists, politicians and financial market pundits all are struggling with what to do next. For many, that decision depends in part on whether they believe the United States is currently in a recession, has avoided one or is on the verge of one.

And that belief is in turn shaped by how they define “recession.”

Even experts have trouble identifying when a downturn becomes a recession and a recession segues into a depression – a deeper, longer downturn, characterized by declines in gross domestic product (GDP) of more than 10%.

Indeed, recessions are often not formally identified until they’re over – making the “yes, we are/no, we’re not” debate raging between different flavors of economists and politicians seemingly meaningless.

Ready or Not, Here It Comes

Importantly, though, many economists view recessions as an inevitable, if unpleasant, part of the business cycle. Recessions are associated with the unwinding of previous excesses (such as the tech-stock bubble). The U.S. economy typically expands for several years and then enters a recession lasting six months to two years.

One common definition of recession is a decline in real (inflation-adjusted) domestic economic activity, or GDP, for at least two consecutive quarters. However, that does not always hold true. The 2001 recession, for example, did not feature two consecutive quarterly declines in real GDP. In addition, by defining recessions in terms of quarters, a recession that lasts 10 months or less could go undetected.

Differences of Opinion

A recession in 2008 isn’t official yet, but many economists, including former Federal Reserve Chairman Alan Greenspan and former Treasury Secretary Lawrence Summers, say the United States has probably entered one. In the other corner, current Treasury Secretary Henry Paulson and Council of Economic Advisers Chairman Edward Lazear say that isn’t so. And even Greenspan recently called the recession “awfully pale,” a far different choice of words than his warning only a few weeks earlier that the country was facing the “most wrenching” downturn since World War II.

The Business Cycle Dating Committee is the arbiter of when recessions in the United States begin and end. This seven-member committee – which included Fed Chairman Ben Bernanke until he was named a governor of the Federal Reserve System in 2002 – is part of a private organization called the National Bureau of Economic Research (NBER). The NBER’s job is to be definitive, not timely, in its declarations. For example, it formally declared that the 2001 recession had begun in late November of that year, just as the recession was ending – and didn’t declare an end to the 2001 recession until October 2003, nearly two years after the fact.

So how does the NBER define recession? In a recent statement, the group declared it to be “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesaleretail sales.” These indicators were trending flat to slightly lower in early 2008. However, an official declaration of recession depends on the depth and duration of a decline in overall economic activity – two or three months of decline isn’’t enough.

So What?

While perhaps interesting, for most people, attaching this sort of description to the state of the economy is irrelevant. Bad times are bad times, regardless of why they’re occurring or what they’re called, now or two years from now. Recent surveys show that most Americans believe we’re in a recession.

One concern is that fears of recession may be self-fulfilling. Indeed, businesses must act on their expectations for the economy. Worried about the future, firms will be less likely to hire new workers or commit to plant and equipment expenditures.

Recessions often provide opportunities for investors seeking bargains. Stock prices typically bottom before a recession ends, as the market starts to anticipate an economic recovery. If the last two recessions are any guide, if we are now in a recession, it’s likely to be short and mild. However, the recovery, like the rebounds from the 1990-91 and 2001 recessions, may be long and gradual.

Raymond James & Associates and Raymond James Financial Services are wholly owned subsidiaries of Raymond James Financial, Inc. (NYSE-RJF).

The information contained in this newsletter has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. We may, from time to time, have a position in the securities mentioned and may buy or sell such securities in the course of regular business.

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