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• Business Cycles: Is the Current Economic Environment Different?

Transcript

Tim Sablik: My guest today is Claudia Macaluso, a senior research economist at the Richmond Fed. Claudia, welcome back to the show.

Claudia Macaluso: Thank you so much for having me again.

Sablik: Since the end of the COVID-19 pandemic, the U.S. economy has been hit by a number of shocks: the post-pandemic inflation spike, geopolitical conflicts, and changes to tariffs and global trade, just to name a few. This has led to frequent predictions that we are on the cusp of entering a recession. And yet, the unemployment rate has only risen gradually since 2023 and it remains at a historically low level. GDP growth has slowed since the immediate aftermath of the pandemic, but it generally remains positive.

Claudia, you recently wrote an interesting Economic Brief article examining the current business cycle in the context of past episodes. Before we get into all that, "business cycle" is a common term in economics and finance. Can you start by explaining how economists define it?

Macaluso: You'd be surprised at how many misconceptions there are about it, so I want to take a step back.

Economists — in particular, economists at the Fed — look at the economy through a variety of measures. Some of those are snapshots — you capture a variable at one point in time, say, the jobs created, new jobs. You can also put those in context through looking at the dynamics — how the number of jobs has changed in the last few months, in the last few years, in the last few decades, and so on and so forth. Once you do that, you will encounter long-term trends. For example, the participation of women in the labor force in the last 50 years has been going up.

The business cycle, on the other hand, would be these short-term or high-frequency fluctuations, the peaks and valleys of economic activity that happen in a relatively short amount of time. We're talking years, not decades, and certainly not multiple decades.

The business cycle is characterized by these two phases: expansions and recessions. We characterize the beginning of a recession when GDP or measures of consumption reach their peak, and then they start going down. For unemployment, it will be the opposite — it reaches a trough and then it starts going up. An expansion will start when we have the top of the unemployment rate and it starts getting better, it starts going down. Up and down and up and down — that's the business cycle.

Sablik: The down part of that cycle, recessions, is something that I think a lot of people would be very familiar with. How are recessions dated or determined in the U.S.?

Macaluso: The responsibility for dating recessions comes to the NBER, the National Bureau of Economic Research. There is a non-partisan committee that dates the recession. Most people maybe don't know, but they are dated ex-post [after the recession].

There is not just one indicator that decides when a recession starts or ends. People very often think of the unemployment rate, but there is also this common idea that two quarters of negative GDP growth make a recession. That's not quite the case.

It depends on three things. One is the depth of the drop relative to previous fluctuations, relative to history — it has to be large, it has to be a severe drop in economic activity. It also needs to be relatively diffused — it cannot be just one sector or just one locality. It has to be aggregate or macroeconomic in nature. And there's also duration — it cannot be a temporary blip. A month doesn't make a recession. And it's not just GDP output, but also employment. It's household income, it's measures of sales and production. There's all sorts of indicators in there.

Sablik: From the perspective of workers or households, unemployment is one of the most visible signs of recession. How does unemployment typically evolve over the full course of a business cycle?

Macaluso: Unemployment generally is a slightly lagging indicator, so it follows the drop in GDP by a couple of months. But it has pretty much the same up-and-down, peaks-and-valleys structure.

It does have a different speed of going up versus going down, as many people notice when they go through such recession, such spells of unemployment. Typically, at the beginning of a recession, the unemployment rate spikes quite quickly. Coming down, on the other hand, tends to be slower. This has been more true in recent times than before. But, in general, we talk about spikes in layoffs signaling the beginning of a recession, of the early phases, and the slow shrinking of the unemployment pool as signaling that we are out of it, we're going towards the expansion.

Sablik: Yeah, you mentioned the type of recovery has maybe changed a little bit over time. Has the length of business cycles changed over time in the U.S.?

Macaluso: It has, and this is actually what the article was about.

We have data on recessions since the 1940s, since WWII. Before 1988, by and large, it took about 18 months to go from the worst of the recession to a normalizing labor market, and vice versa. If you look instead at the same up-and-down cycle after 1988, it's actually almost 38 months — 30 if you consider also COVID. COVID was an especially fast recession, and clearly one that doesn't have many comparable episodes in history.

Sablik: How does the current business cycle that we're in right now compare to past ones, particularly in terms of the labor market?

Macaluso: That's quite interesting. First of all, let me situate the place where we are at. We are heading towards a recession. Now, don't get alarmed. I'm not revealing anything special.

Sablik: You heard it first here, folks.

Macaluso: [Laughs] That means that we have passed the trough of the unemployment rate. That was in April 2023 when we were at 3.4 percent. It's been higher ever since. Technically, that's a recession.

You don't see the same level of distress that the word recession conjures to the mind. What's special about this is that we reached a trough and we've been going up. And typically, you expect things to get bad very quickly, except they haven't they. In fact, we've seen a growing of the unemployment rate very slowly, baby steps, so to speak. (Not that we want big steps.) In fact, this cycle, so far, is the longest on record that we've had an increase in the unemployment rate without a broad-based, deep recession.

Just to give you a comparison, which to me was quite striking, we are about 34 months into the "recession." (I'm gonna sort of try to express the quotes around that name.) We have seen an increase in the unemployment rate [of] about one percentage point — we went from 3.4 to around 4.4, 4.5. In the Great Recession, the same amount of months gave us an increase of five percentage points, so five points larger than now in the same amount of time. So, in this sense, it's certainly a very slow deterioration of the unemployment rate.

Sablik: What does the unprecedented nature of this current cycle mean for policymakers?

Macaluso: That's a hard question. I think, on the one hand, it's a genuine puzzle. We are seeing something new. To be fair, we're seeing a lot of new — we've just come out of a historic pandemic and the cycle after it — so part of it is a normalization of the very strange labor market that we had at some point between COVID and the post-COVID recovery.

To me, even though it doesn't ring alarm bells across the board, the increase in the unemployment rate has been quite sustained and that appears concerning. There is no reason to run out the door screaming in despair, but there's also very little reason to be very sanguine, very positive about the economy. Policymakers remain in a wait-and-see posture, alert to what may happen to the economy. But we are very cognizant that the signs don't look especially rosy.

Sablik: Maybe economists will have to come up with a third category for not expansion and not recession.

Macaluso: Exactly, exactly. We actually thought about it. There has been a change in technology, a change in trade patterns, a change in geopolitical factors. So, perhaps we also have to come up with a new way to date the recessions and the cycles to begin with.

Sablik: Claudia, thank you so much for joining me today to talk about this.