Unexpectedly Intriguing!
09 August 2007

We like to play around with new ways of visually presenting economic data here at Political Calculations, so when Bill Polley recently observed that the standard definition of a recession doesn't seem to describe the state of the economy very well, we saw it as an opportunity. Here's what he had to say:

Can we lose the definition of "two consecutive quarters of declines in GDP"? By that definition, we didn't have one in 2001. What we had was three quarters of negative growth, but they were every other quarter. One down, one up... one down, one up.... one down, one up. Definitely a recession, there's no question about that. But the standard textbook definition is obsolete.

Likewise, even though the most recent quarter posted growth above 3% doesn't mean that this is a trouble-free economy. Just about everyone acknowledges that growth for the rest of 2007 will be weaker, perhaps significantly weaker. If we have two quarters of growth around 1%, will it feel like a recession? Perhaps in many ways, yes. Would it meet the textbook definition? No.

This is not your father's economy, and the textbook definitions that worked in the '70s and '80s to explain the malaise of the time are not applicable now. We need to get out there and educate the next generation as to the subtleties of economic statistics, lest they become disillusioned that economists and the media are out of touch with their textbook definitions from the '70s.

In the comments for Bill's post, we observed that something like a temperature scale might be a better way to represent GDP growth, similar to what Steve Conover has done with International Debt Burden comparisons at the Skeptical Optimist, and which we feel can do a good job at communicating whether the economy is too cold (growing too slowly, as in a recession), too hot (growing too fast, potentially sparking inflation), or growing just fine.

The question then becomes, where do you draw these lines? That part of our answer was provided by David Tufte of voluntaryXchange, who developed a method for assigning grades to GDP growth back in July 2005:

The iniital estimate of the real GDP growth rate for the second quarter will come out Friday morning, and it is useful to have a metric to put it in perspective. So, here's a letter grade scale:

  • A - 5.4% or higher
  • B - 3.5% to 5.3%
  • C - 1.6% to 3.4%
  • D - 0.1% to 1.5%
  • F - 0.0% or less

We used these thresholds to create our "temperature" bands, with the top of the "cold" transition set at 1.5%, "cool" at 3.4%, "just right" at 5.4%, and so on, with some educated guesses of where to draw the lines for higher thresholds.

We next "blended" the transitions between the thresholds so we have something more like a true temperature spectrum. Here's our first cut at visualizing recent GDP data using the most recently reported advance estimate for the second quarter of 2007:

1-Quarter Real GDP Growth Rate 2007Q2 Advance Estimate

The bullet chart above shows the 1-Quarter Real GDP growth rate of 3.4% for the second quarter of 2007 (2007Q2), and also provides what the figure was for the previous quarter (the vertical black line on the chart) against the backdrop of typical GDP performance for the U.S. economy (the "temperature" spectrum.)

However, there is a bit of a problem in that the 1-Quarter GDP growth rates have quite a bit of volatility that makes it difficult to see just how well the economy is doing overall. Did economic activity really pick up 2.8% in just one quarter? Can the world's largest economy really turn on a dime like that?

The solution to this problem is to look at GDP growth rates over longer periods of time, getting something like a moving average. Once again, we turned to the Skeptical Optimist's method of examining GDP growth rates over a 2-quarter period:

2-Quarter Real GDP Growth Rate 2007Q2 Advance Estimate

In this bullet chart, we compare the annualized 2-Quarter Real GDP growth rate for the period ending in the second quarter of 2007 with the previous 2-Quarter Real GDP growth rate for the period ending in the first quarter of 2007 and against the backdrop of historic U.S. economic growth.

Aside from smoothing out the volatility in the 1-Quarter approach, the 2-Quarter method would also be capable of picking up the situation where the economy is dipping in and out of negative growth territory, such as in 2001, making it easier to make a solid recession call.

For the most recent GDP data, we find that the U.S. economy has been operating in the "cool" range of its historical performance spectrum, but has warmed up in the most recent period.

We think it may well be a better way to look at GDP growth in the U.S.

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