GDPplus, a better recession indicator than GDP?

While gross domestic product (GDP) gets most of the attention, gross domestic income (GDI) better captures business cycle fluctuations in true output growth. It turns out that GDPplus – which subsumes both – can be a better recession marker than GDP or GDI on their own.

What’s the difference between GDP and GDI?

GDP, which measures overall economic activity by final expenditures, gets a lot of attention because it’s relatively prompt, being released a few weeks after a quarter ends.??

GDI, which measures the incomes generated from producing GDP, is often overlooked because it’s released one month later.

To be clear, GDP and GDI are conceptionally equivalent coincident indicators.

Why you should pay attention to GDPplus

The Philly Fed’s GDPplus is based on information extracted from both GDP and GDI in a statistically optimal way. GDPplusis a smoother and better estimate of the underlying, but unobserved, U.S. economic activity that drives GDP and GDI. That’s why it’s worth paying closer attention to its movement.

GDPplus is telling us the U.S. economy may have already slipped into recession

As the chart shows, the quarter-over-quarter annualized growth rate of real GDPplus has never been this negative outside a recession (horizontal dashed red line).

Unless the GDI and GDPplus data are drastically revised, the implication is that the U.S. economy may have slipped into recession in late 2022 or early 2023.

How can there be recession if GDP is positive?

It’s hardly ever evident from the GDP data in real time that the economy is in recession. A recession typically becomes obvious long after the fact.

A case in point is the 2007-09 Great Recession, which – as we now know – began in December 2007. Yet, it wasn’t until July 31, 2008 – at least seven months inside the recession – that a negative reading on GDP growth was first released, when Q4 2007 GDP growth was revised from +0.6% to -0.2%.

Even so, that single quarter of slightly negative GDP growth wasn’t enough to convince the consensus that the economy was in recession. It took the collapse of Lehman Brothers in mid-September 2008 for most to accept that a recession was underway. That’s why it’s important to examine key coincident indicators – not just GDP – to ascertain whether a recession has begun.

Digging deeper into the key coincident indicators

A recession is a specific sort of vicious cycle, with cascading declines in output, employment, income, and sales that feed back into a further drop in output, spreading rapidly from industry to industry and region to region.

Looking at each measure below, we can dig deeper into where we are in the business cycle.

Industrial production: A narrower measure of output than GDP - industrial production - peaked last fall and slipped in its latest reading.

Sales: The broadest measure of sales – real manufacturing and trade sales – having peaked early last year, dipped yet again in its latest reading. A narrower metric – real retail sales – peaked over a year ago, and its year-over-year growth rate has been negative for seven straight months; that’s never happened outside a recession.

Employment and Income: The obvious holdout is employment, which has kept rising for a variety of reasons, including unusual shifts that have followed the Covid crisis – and this is also why personal income has held up. But especially in inflationary eras like the 1970s, the “money illusion” staves off job cuts by businesses fixated on nominal revenues, which keep rising due to inflation. Recall that the severe 1973-75 recession started in November 1973, but nonfarm payroll jobs growth turned negative only in August 1974. In other words, it doesn’t require job losses for a recession to begin.

The next time someone confidently declares that we’re not in recession, it may be worth asking, “How do you know?”