What shows that a country is experiencing a recession?

Indicators that a country is experiencing a recession.

Most experts say there’s no need to panic just yet, but there are a number of datasets you may want to watch to help signal future economic shocks. They’re generally referred to as “indicators,” and they’re what experts read when trying to spot-check the health of the national economy.

A recession can be defined as a sustained period of weak or negative growth in real GDP (output) that is accompanied by a significant rise in the unemployment rate. Many other indicators of economic activity are also weak during a recession. For instance, levels of household spending and investment by businesses are usually low. In addition, the numbers of households and businesses that are unable to pay back loans are unusually high, as is the number of businesses that close down. Because these indicators are typically present when there is a significant increase in the unemployment rate, the unemployment rate is considered a reliable and timely summary indicator of a range of negative developments in an economy.

The economists look at several factors to determine if the country is in recession. Industrial production, interest rates, employment numbers and whether those numbers are declining are all factors the economists use to determine whether the country is in a recession.

A recession is when the GDP growth rate of a country is negative for two consecutive quarters or more. But a recession can be gauged even before the quarterly gross domestic product reports are out based on key economic indicators like manufacturing data, decline in incomes, employment levels etc.,

A recession basically means that the economy isn’t growing — and the barometer of economic growth is a measure called gross domestic product (GDP). This means it’s worth monitoring this quarterly data because any signs of a faltering economy are bound to show up here.

Economists say there are several more timely indicators that could signal a recession. Consumer spending and sentiment are both key measures to watch, especially if Americans start to buy fewer goods that aren’t necessities, like new couches or cars. Some of these metrics suggest the economy might be starting to cool: Consumer spending rose 0.2 percent in May, the weakest monthly gain this year. Retail sales have shown slight signs of weakening, and a recent Conference Board survey found that consumer confidence has plummeted to its lowest level since February 2021. But overall, consumer spending has been relatively strong.

Rising unemployment: It goes without saying that if people are losing their jobs, it’s a bad sign for the economy. Just a few months of steep job losses is a big warning of an imminent recession, even if the NBER hasn’t officially declared a recession yet.

A recession is a significant decline in economic activity that lasts for months or even years. Experts declare a recession when a nation’s economy experiences negative gross domestic product (GDP), rising levels of unemployment, falling retail sales, and contracting measures of income and manufacturing for an extended period of time. Recessions are considered an unavoidable part of the business cycle—or the regular cadence of expansion and contraction that occurs in a nation’s economy.

The National Bureau of Economic Research (NBER) defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months.” The decline would normally be visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

Still, forecasters say there are some numbers they will be watching closely — most important, the job market. Recessions, almost by definition, result in lost jobs and increased unemployment. And increases in unemployment, even fairly small ones, nearly always signal a recession.

Correlation between GDP growth and inflation.

The relationship between inflation and economic output (GDP) plays out like a very delicate dance. For stock market investors, annual growth in the GDP is vital. If the overall economic output is declining, or merely holding steady, most companies will not be able to increase their profits (which is the primary driver of stock performance). However, too much GDP growth is also dangerous, as it will most likely come with an increase in inflation, which erodes stock market gains by making our money (and future corporate profits) less valuable. Most economists today agree that 2.5 to 3.5% GDP growth per year is the most that our economy can safely maintain without causing negative side effects. But where do these numbers come from? To answer that question, we need to bring a new variable, unemployment rate, into play.

Over time, the growth in GDP causes inflation. Inflation, if left unchecked, runs the risk of morphing into hyperinflation. Once this process is in place, it can quickly become a self-reinforcing feedback loop. This is because, in a world where inflation is increasing, people will spend more money because they know that it will be less valuable in the future. This causes further increases in GDP in the short term, bringing about further price increases. Also, the effects of inflation are not linear. In other words, 10% inflation is much more than twice as harmful as 5% inflation. These are lessons that most advanced economies have learned through experience; in the U.S., you only need to go back about 30 years to find a prolonged period of high inflation, which was only remedied by going through a painful period of high unemployment and lost production as potential capacity sat idle.

There is as much debate over how to calculate GDP and inflation as there is about what to do with them when they're published. Analysts and economists alike will often start picking apart the GDP figure or discounting the inflation figure by some amount, especially when it suits their position in the markets at that time. Once we take into account hedonic adjustments for "quality improvements," re-weighting, and seasonality adjustments, there isn't much left that hasn't been factored, smoothed, or weighted in one way or another. Still, there is a methodology being used, and as long as no fundamental changes to it are made, we can look at rates of change in the CPI (as measured by inflation) and know that we are comparing from a consistent base.

Figure 1 shows the trend in four of the NBER committee’s recession-indicator variables—real income minus transfers, real spending, industrial production, and employment—relative to their values in April 2020 (the trough of the last recession, and thus, the month before the current expansion began). All of these indicators have exhibited strong growth in the U.S. economy since the start of the pandemic, and have continued to expand through the first half of this year. And while real income net of transfers has been flat in recent months, industrial production, employment, and real spending have grown this year. The committee does not directly consider inflation; however, it is embedded in the real income and spending variables it tracks, including those plotted in Figure 1. Those data show that while inflation is highly elevated, real spending is still growing, powered by one of the strongest labor markets on record and an elevated stock of household savings.

The most important determinant is disposable income. That's the average income minus taxes. Without it, no one would have the funds to buy the things they need. That makes disposable income one of the most important determinants of demand. As income increases so does demand. If manufacturers ramp up to meet demand, they create jobs. Workers' wages rise, creating more spending. It's a virtuous cycle leading to ongoing economic expansion. If demand increases but manufacturers don't increase supply, then they will raise prices. That creates inflation.

The biggest reason behind this argument in favor of inflation is the case of wages. In a healthy economy, market forces will, at times, require that companies reduce real wages, or wages after inflation. In a theoretical world, a 2% wage increase during a year with 4% inflation has the same net effect to the worker as a 2% wage reduction in periods of zero inflation. But out in the real world, nominal (actual dollar) wage cuts rarely occur because workers tend to refuse to accept wage cuts at any time. This is the primary reason that most economists today (including those in charge of U.S. monetary policy) agree that a small amount of inflation, about 1% to 2% a year, is more beneficial than detrimental to the economy.

There are times when it is most helpful to simply take the inflation and GDP numbers at face value and move on, especially since there are many other things that demand our attention as investors. However, it is valuable to re-expose ourselves to the underlying theories behind the numbers from time to time so that we can put our potential for investment returns into the proper perspective.

Gross domestic product (GDP) in the United States represents the total aggregate output of the U.S. economy. It is important to keep in mind that the GDP figures, as reported to investors, are already adjusted for inflation. In other words, if the gross GDP was calculated to be 6% higher than the previous year, but inflation measured 2% over the same period, GDP growth would be reported as 4%—or the net growth over the period.

“When actual GDP is rising above its potential, we’ve historically seen these trends where the actual GDP rises above potential and it hits sort of a peak, rolls back over and falls below potential,” Donisanu says. “These are the cycles that ebb and flow over time.”

Consumer spending, for example, grew at a solid 1.8 percent annual rate in the first quarter, adjusted for inflation, and most forecasters believe it grew in the second quarter, too, albeit more slowly. Job growth has remained robust. Other measures, such as industrial production and inflation-adjusted income, have stalled in recent months, but haven’t fallen significantly.

Reduced levels of consumer spending.

Economic output, employment, and consumer spending drop in a recession. Interest rates are also likely to decline as the central bank (the Federal Reserve in the U.S.) cuts its benchmark rate to support the economy. The government's budget deficit widens because tax revenues tail off, while spending on unemployment insurance and other social programs rises as more people qualify for the benefits.

The GDP report showed that businesses had retrenched. Undoubtedly, borrowing has become more expensive with the Federal Reserve ratcheting up interest rates. So there's less money to invest. The key worry is whether that will start hurting jobs growth.

If for some reason consumer confidence declines, consumers become less certain about their financial prospects, and they begin to spend less money; this in turn affects businesses as they begin to experience a decrease in sales. If consumer spending continues to decline and businesses begin to cut back on production, the economy experiences a slowdown and may eventually enter a recession.

There is a further question of whether changes in demand are induced by current restrictions or by uncertainty about future job prospects. A full analysis requires data on spending responses by occupation because different sectors face different risks.

Any fall in spending will have implications for saving rates: for those without a change in income, reduced consumption leads to extra saving. For those whose income has declined alongside consumption, it is unclear whether savings will go up or down.

In frothy periods of national prosperity, marketers may forget that rising sales aren’t caused by clever advertising and appealing products alone. Purchases depend on consumers’ having disposable income, feeling confident about their future, trusting in business and the economy, and embracing lifestyles and values that encourage consumption.

The shock of the current downturn and anger over the malfeasance that fueled it will likely accelerate preexisting consumer trends toward reduced materialism, commitment to sustainability, higher expectations of corporate social responsibility, and resentment of marketing that treats people as soulless, mechanical consumers. Customers will increasingly demand that businesses act in their—and society’s—best interests. And they’ll factor companies’ business practices into their brand choices.

The economy would have to rely on exports, assuming other countries kept up their consumer spending. Borrowing would keep the government and factories open. These additional components of the gross domestic product aren't as critical as consumer spending.

The Covid-19 pandemic has triggered an unprecedented spike in job loss and fears about a potentially deep and persistent recession, largely due to depressed consumer spending. Given the important role of consumption in the UK economy, it will be crucial to understand the determinants of diminished spending in order to design policy to support households during the pandemic and guide the country out of recession.

During recessions, of course, consumers set stricter priorities and reduce their spending. As sales start to drop, businesses typically cut costs, reduce prices, and postpone new investments. Marketing expenditures in areas from communications to research are often slashed across the board—but such indiscriminate cost cutting is a mistake.