Some observers claim the U.S. economy is recovering; others say we are in recession. Both are describing the same economy, yet their perspectives are polar opposites.
Recession and recovery are subjective terms that describe phases of the business cycle. Economically speaking, a recession is a downturn in economic activity. But that leaves a lot of room for disagreement. To better define and measure recession, economists now rely on the National Bureau of Economic Research's (NBER) requirement that four measures of economic activity – industrial production, employment, trade and income – must decline in three consecutive quarters.
Former President Ronald Reagan gave the most populist definition of business cycles during his campaign against former President Jimmy Carter. Carter harangued Reagan heavily about a confusing reference to recession. Reagan responded that, as he understood economics, "When your neighbor loses his job, it's a recession. When you lose your job, that's a depression. And, when (Carter) loses his job, we're on our way to recovery."
Except for the jab at Carter, that isn't far removed from economic reality. Although business cycle theory deals with aggregate performance, demand theory is well-grounded in the appeal goods and services hold for individual consumers.
For example, factories hum during good times, but the minute durable goods producers detect pessimism or reservations by consumers, they will cut back; perhaps to the extent of closing down assembly lines or laying off workers. Those workers probably will decide to forego or delay purchases of some goods and services. Waiting until "things get better" can mean that kids stop buying video games, family members stretch extra weeks out of haircuts, that they buy only essentials at supermarkets or, in adverse situations, the family's standard of living actually declines.
Enough of that kind of thinking can stop an economy in its tracks. It did during the Great Depression. There were many instances during the 1930s of testimony before Congressional committees by Eastern politicians begging for government assistance because so many citizens were starving, while Western farmers and ranchers told those same committee members about driving cattle and sheep herds over a cliff because they could not afford to feed them. People needed food, but had no means to buy it; others had food, but no market in which to sell it. In the midst of all this fiscal confusion, the Federal Reserve tightened monetary policies.
In response, Keynes' theory that expansionary government spending could "prime the pump" received a real-life test from the incoming Roosevelt Administration. Keynes' basic premise was that government should fund work when industry lulled, keeping workers employed and, most important, money circulating. Some Midwestern cities still save government construction and other spending projects for slow economic times.
After 1932 the U.S economy didn't get worse, but it didn't get much better. Nobel Prize winner Milton Friedman's genius was recognizing that the Fed's tight money policies were literally strangling consumers and businesses. Even if they had wanted to invest, spend or consume, who had the money? So the economy remained stalled.
It took America's entry into World War II to revive it. But did increased production on war materiel boost the economy, or was it workers drawing a regular pay check? Probably both, but jobs alone might not have solved our economic woes had there not been confidence that life, and not just the economy, was getting better and would continue to improve.
Today, after the destruction of the World Trade Center and the prospect of a long and protracted struggle against terrorism, the U.S. economy is growing. NBER's business cycle measures – industrial production, employment, trade and income – largely have increased, though slightly, during the past few quarters.
So what is the answer to the question – Are We in a Recession? Using NBER measures the answer is yes in the last three quarters of 2001, but not so far in 2002. But given a certain levels of technology, education and culture, economic activity mostly depends on consumer confidence – how we collectively feel about the economy and its future. That's why my colleague, NCPA Senior Fellow Bruce Bartlett, and I went on national television in the days after the September 11 terrorist attacks to urge individuals and institutions to buy stock and support U.S. markets. Unfortunately, while experiencing highs and lows throughout the past year, consumer confidence levels (as measured by the Conference Board) are generally sluggish right now
Perhaps after decades of recondite mathematical advances in theory, economists and economic policy makers will begin to learn what advertisers and marketers always have known – financial decisions are limited by the pocket book, but sales are made in the mind.