6 August 2023

Australia might have a recession in name only

As Australia’s economy slows, largely in response to higher interest rates, a key question is whether the country will fall into recession. Our central case is that growth will be close to stall speed, averaging 0.1 per cent for the next four quarters, and the unemployment rate will rise by around 1 percentage point. We expect per capita household consumption to fall. While the economy may feel very sluggish, we expect a recession to be avoided.

But what then do we mean by recession? Some observers might be surprised that such a widely used economic term is so ill-defined.

The most commonly cited definition is two consecutive quarters of falling gross domestic product. This is often referred to as a “technical recession”. But although simple to explain, this definition is problematic. Some examples help.

Early last year, the US had two consecutive quarters of falling GDP but at a time when many other indicators were strong. In particular, employment growth was solid and the unemployment rate at a multidecade low. Given this, it made little sense to suggest that the US economy was in a recession, despite the GDP prints.

More recently, Eurozone growth figures have been revised multiple times. Around the turn of the year they indicated no technical recession, then they did, before flip-flopping again last week. In this case, is the term recession really that useful?

Meanwhile, New Zealand’s economy has recently tipped into a technical recession, but employment growth has been strong and the labour market participation rate is at an all-time high. With the jobs market so resilient, is the economy really in a recession?

Looking back at Australia’s own history, the economy famously avoided having two consecutive quarters of negative GDP in late 2008, when the Global Financial Crisis struck. However, growth fell sharply in the fourth quarter of 2008. If the weakness is concentrated all in one quarter, strictly speaking it is not a technical recession. But the unemployment rate rose sharply, by 1.8 percentage points, during that episode. Given the significant jobs market weakness, did the economy really avoid a recession?

Another factor to consider is population growth and whether a fall in per capita GDP should be deemed a recession. In fact, the key criteria the International Monetary Fund uses for defining a global recession is when global GDP growth falls below that of population growth.

Living standards

If per capita GDP is the most important metric, then Australia is now almost certainly in a recession. Australia would also have had a recession in 2000, 2006 and 2020. Based on this definition, Australia did not have its much-acclaimed “longest boom”, recording 28 years of continuous growth before the pandemic.

Ultimately, when making the judgment about whether the economy is in a recession, it is important to ask what we are trying to measure.

If the aim is to judge whether living standards are improving, then per capita GDP is a better measure. This is because the key to lifting living standards is generating more output for every input – that is, to measure if productivity is rising.

But the term recession is not typically used to describe an economy’s productivity performance. If per capita GDP is falling, productivity may not be improving, but the economy is not necessarily in a recession. Instead, a recession is a way of describing which stage of the cycle an economy is in.

A common theme here is that GDP itself is not enough to gauge whether an economy has tipped into a recession. A broader assessment of a range of indicators is needed, and this likely requires some judgment.

The US takes a different approach to this problem. The National Bureau of Economic Research has a business cycle dating committee, which has existed since 1978. It defines a recession as a “significant decline in economic activity that is spread across the economy and that lasts more than a few months”. To make its determination, the committee – largely made up of academic economists – looks at a broad range of economic indicators.

With all of this in mind, even if a technical recession were to arrive in Australia in the second half of 2023, it would be debatable whether it was an actual recession, especially if the unemployment rate rose only modestly, as we expect. Judgment will be required.

In short, the next time you read about whether Australia is set to have a recession or not, keep in mind that it is not as clear-cut as it seems. Perhaps the answer is that Australia should consider setting up a business cycle dating committee of its own. More clarity about such an important concept would surely be helpful.

This article first appeared in the Australian Financial Review on 6 August 2023.