How to Know When a Recession Has Started

At the end of August, the government updated its economic numbers for the U.S. economy’s performance in the April-June quarter. The update confirmed what it had reported last month: That the economy shrank for two straight quarters. 

Six months of economic contraction is a widely held but informal definition of a recession. The post-pandemic era very well may be rewriting the definition of a recession. Inflation has been raging, wages are growing, employment is up, and unemployment is at a 50-year low. None of those are indicators of a recession. The six-month decline in economic output is the only strong indicator of a recession. So, are we in one or not?

recession

It’s a Mixed-Up Economy

More likely, the post-pandemic economy and major shift of economic power to Millennials are reshaping the economy. Inflation is still so high that despite pay raises, most Americans’ purchasing power is eroding. Most people feel inflation in their day-to-day purchases – essentials like food, gas, and rent. 

Make no mistake about it, the Federal Reserve is at war with inflation. There have been four consecutive interest rate hikes that have pushed borrowing costs to the highest level since 2019. This is boosting consumer borrowing costs for items more associated with a recession – homes, cars, and credit card purchases. What we are experiencing is purchasing power erosion on two economic fronts – short-term and long-term purchases. This is key to why many economists are saying we are not currently in a recession (even with six months of economic decline), but we are headed for a recession later this year or in 2023. After inflation has been tamed but long-term spending remains in decline.

We often don’t know when we are in the early months of a recession. Six months decline is unofficial. Recessions are officially declared by the obscure National Bureau of Economic Research, a group of economists whose Business Cycle Dating Committee defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.” All of their data is hindsight. None of it is forward-looking. They use many data points to define a recession with major indicators being gauges of income, employment, inflation-adjusted spending, retail sales, and factory output. It puts heavy weight on jobs and a gauge of inflation-adjusted income that excludes government support payments like Social Security. Ultimately, the NBER typically doesn’t declare a recession until well after one has begun, sometimes for up to a year.

That is why economists look for earlier signs that a recession has begun or is coming. Six months of economic decline has been a leading indicator in each of the past 10 recessions. A half-point rise in the unemployment rate, averaged over several months, is another historically reliable sign of a downturn. So, unless you want to learn after the fact that we are in a recession, know that we’ve had six months of decline and watch unemployment as the second key indicator.

What a Recession Probably Means for Real Estate Markets

Housing supply and demand is another twist in today’s economy. The severely low supply continues fueling demand and higher home prices. This is a key reason why so many housing experts say the market will remain strong for years to come. That doesn’t mean it will be good for low-income buyers, but it also doesn’t mean that there will be a major shift from a sellers’ market to a buyers’ market. Most first-time buyers are younger than 40 (Millennials and Gen Z), which means the buyer pool is deep — the best indication that demand will remain strong. Especially since housing inventory remains at historical lows.

A recession will almost certainly cut the legs out from under low-income buyers, which will reduce demand. However, it’s not likely to reduce demand to the extent that an oversupply develops. It is also a fact that higher interest rates will remove another segment of buyers — another drop in demand. The combination should cool home prices. At least the growth of home prices (which was still growing at 6.6% in July). To what degree the housing market will ease, however, is up for debate. Key factors to watch include how hard a recession hits individual regions, how long the recession persists, and if home construction increases or decreases. The bottom line is that home prices are likely to see some relief, but buying a house during a recession is still, well, buying a house during a recession. Many will be excluded from the market and only the most financially robust buyers are likely to prevail. However, sellers will find plenty of buyers in the market.

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