The word recession is hard to avoid these days. Despite the term being on the tips of everyone’s tongues, there still seems to be confusion about the basics. Is there going to be one? How bad will it be? How do you even define the term? Apparently even that old, go-to definition that a recession is two consecutive quarters of negative GDP growth might not be too simplistic.
So, in this episode we go back to basics for a primer on this seemingly nebulous economic term with the help of our guest, Scotiabank Chief Economist Jean-François Perrault.
Click here for the transcript.
Jean-François Perrault: Well, yes and no.
SM: That's Scotiabank's Chief Economist, Jean-François Perrault.
JFP: So, there's a shortcut for a recession, which is two consecutive quarters of negative growth. But that doesn't tell you a whole lot about the state of the economy. You can have two negative quarters for technical reasons or for just blips in the data that don't really mean the economy is in a bit of a hard situation.
SM: So, I guess we need to go back to basics on this whole recession thing, and J.F. is the perfect person to help with that. This episode is here to give us some clarity on this seemingly nebulous economic term. I'm Stephen Meurice, and this is Perspectives.
JF, thanks as always for being on the show.
JFP: Thanks, Steve. Always a pleasure to talk.
SM: Usually we have you on to break down the news of the day. But today we have you on to solely explain one thing: what is a recession? So, let’s start with a definition. In the intro you said “not so fast” on the definition one I often hear and use myself, about two consecutive quarters of shrinking GDP. If that's not the definition, what is?
JFP: Well, a broader definition of recession is one that looks at the actual decline in economic activity, how broad based that is, what's going on with employment. That's more of a qualitative assessment. It's longer. You often diagnose it well after the recession is officially kind of declared. But that's a more complete definition or picture of recession. And that call is made, for instance, by the C.D. Howe Institute or others to look at the full suite of economic indicators to really get a sense of what's happening in economy, just to make sure that we're not catching these little blips in data that can give you a couple of quarters of negative growth pretty easily in most circumstances.
SM: Okay. You mentioned the C.D. Howe Institute and I'll get back to that. But first, I have to ask if that two quarters of negative growth rule isn't actually the official definition of a recession, where did that come from?
JFP: Oh, it's been around forever. I mean, you know, there is value in knowing when there's a recession, right? But there's such a broad range of macro economic variables you need to look at to make an official call that folks kind of take a shortcut. Say, “Okay, well let's look at if you got two quarters negative growth, we'll kind of say roughly speaking, that’s probably a recession. We’ll confirm that later. We'll have more information.” But it's just a quick and dirty way of getting a sense of how serious a slowdown is.
SM: I was going to ask you whether there is some kind of governing body that sort of officially declares whether there's a recession or not? In the States, they have this thing which I hadn't heard of until recently, the National Bureau of Economic Research, which seems to have that authority to call a recession or not. We don't have anything like that in Canada, do we?
JFP: That's right. It's really kind of the C.D. Howe Institute that I would say, is probably the institution that folks most look to, to make that assessment in Canada. That's a think tank. It's not a government organization, but nor is the National Bureau of Economic Research in the U.S., a government organization. They're not quite the equivalent of the C.D. Howe Institute, but they're a bunch of, you know, professional economists who look at a broad range of things, just like we do here, to make this call as to whether or not an economy is actually going through a meaningful slowdown, as opposed to just a technical slowdown that's captured by two quarters of negative growth.
SM: Right. So, either while it's going on or potentially even after the fact, there might be some dispute as to whether one actually happened or not?
JFP: For sure. For instance, we could end up with a couple of quarters negative growth in Canada this year, next year, we'll see. And it'll take several months after that, usually to make a formal assessment as to whether or not that was a true recession as opposed to just a technical recession.
SM: And a technical recession is what you call it when there's two back-to-back quarters of negative growth.
SM: Okay. Can we maybe look backwards a little bit? Can you give us a bit of a history lesson? When were the last couple of recessions in Canada and what did they look like?
JFP: So, there was one during the pandemic. So that was kind of considered a recession. And then you've got to go back, say, to the great financial crisis, which would have been the most recent one before that. And then you've had a few other ones over history.
SM: When you say great financial crisis, you mean 2008, right?
JFP: That's right. But recessions are kind of scary episodes, right? They’re periods of time when people are worried about the state of the world, where businesses cut back on spending, when there are layoffs, when households are financially affected either by layoffs or by a fall in income, or by just being more cautious about things. Recessions are very often historically triggered by higher central bank policy rates. So, there is a pretty good correlation, historically, central banks raise interest rates to control inflation, that reduces economic activity. It's very difficult to be super precise about the exact number of interest rate increases you need to achieve the inflation outcome that you want. So central banks historically have tended over tighten and that helps precipitate a recession. The pandemic, you kind of got to filter through because it was the basically the government decided to close the economy. So that's not really kind of an organic thing. But the most recent one before that was the financial crisis. And that was hard on Canada, that was hard on a lot of countries. And that's a kind of a typical, meaningful recession.
SM: So, they're not all created equal. Different factors go into each one. How long would they typically last?
JFP: So, it depends on the nature of the recession. Recessions usually aren't that long, right? They’re a couple of quarters, maybe three quarters. And the financial crisis was a longer recession. And it was a longer recession because it was kind of, in our speak, a balance sheet recession. And a balance sheet recession basically means when, say, a central bank raises interest rates or there are problems with balance sheets of households and firms that are exposed, it is a very lengthy process for those balance sheets to be adjusted, to be cleaned. It's not something that happens overnight. It can take a few quarters, a few years. So we saw in the great financial crisis, for instance, this balance sheet recession, which hit — so very negative outcomes in the first — triggered by financial crisis. But the recovery from that was very lengthy because firms and households in Canada, in the U.S. and Europe needed a lot of time to clean their balance sheets, to, you know, make sure they're on solid financial footing for an eventual expansion.
SM: Right. If we do have a recession in 2023, which some people think we will, including you, you've mentioned do you think we'll have a technical recession early next year. What's that likely to look like? I mean, I know you can't predict exactly, but how bad might it be?
JFP: Well, if you look at the starting point, cause starting points matter for recessions, right? If you go into a period of economic weakness and balance sheets are impaired, that makes it worse. So, a starting point, for instance, for us in thinking about how bad recession might be if there is one next year, is to look at the state of household and corporate balance sheets. And they’re, by most measures, they are in very, very good shape relative to, say, ten years ago, last financial crisis. Sure, they've degraded a little bit. Equity prices and house prices have come down. That's had an impact on household balance sheets, but they're still pretty clean by a historical perspective. And that’s true on the corporate side as well. So, we have a pretty good sense that balance sheets are going to be reasonably resilient in a period of economic weakness. Which means that if there is a recession, you're not likely to get that kind of 2008/2009 type of recession, where it takes a long time for firms and households to clean their balance sheets in response to economic shock. The other factor that's important from a recession perspective in terms of depth is what happens in the labour market. Because, of course, you know, when firms lay people off, those laid off people experience significant financial hardship and it can take a while for them to reintegrate into the labour force. And, you know, what we're seeing now is we probably have the tightest labour market we’ve ever seen in the country. Firms are still complaining about labour shortages. Still the number one issue that many firms are contending with. You know, inflation is obviously a problem. They're less worried about recessions, they're more worried about job shortages. So, with about a million vacancies, which is the most recent data, you've got a large buffer there. When you consider a historically typical recession will see about three to four hundred-thousand jobs shed. So, it suggests that firms have a fair amount of ability to reduce the number of vacant positions, cut back on anticipated hiring as the first line of defense. And then you think about in terms of that, because the labour market has been so tight for quite a while now, it's been very expensive and very difficult for firms to attract and retain workers. And having gone through that investment, having gone through those challenges, firms are unlikely to shed labour as rapidly as they might have in the past. So, we think there would be some element of labour hoarding. Firms will try to hold on to workers for as long as they can because they don't want to find themselves in a position of going back into the market, being very challenged in terms of being able to hire people. Because that has been the principal business challenge for the last, well basically since we've started coming out of the pandemic. In fact, it was a problem pre-pandemic as well. So those two things together, these labour shortages, the strength of labour market plus the fact that balance sheets are pretty clean, suggests to us that if there is a weakness, it's not likely to be the type of weakness that we've seen in past recessions.
SM: So, if unemployment is less of a concern in this potential recession than it might have been in previous ones, and if balance sheets. So, the state of household finances and business finances, if those are in pretty good shape, what could the impacts be? What should people be worried about if there is a recession?
JFP: Well, the first thing is it's one thing to say we think the recession would be mild if there is one, but we don't know, of course, right? And there's a certain amount of psychology at play here, sociology at play. When people are worried, they react in a way that they believe is in line with their best interest. So, they may not be at risk of being laid off. Certainly from a historical perspective, that's definitely true, but they may not perceive it that way. So, they might still act as if, you know, there is kind of this really bad situation that's going to hit them down the road. So that can actually make things worse, right. You can end up in a situation where firms and households anticipate weakness that wouldn't occur otherwise, wouldn't occur if they actually didn't cut back on spending for fear of that occurring. We've got to keep that in mind as we think about the recession scenario, that there's this possibility that fear just breeds upon itself and makes things worse than what the macro situation would suggest. But, you know, a recession means growth falls, right? That the level of economic activity declines somehow. So that means that firms and households, or both, have reduced their level of spending. There has to be some pain. If you think of it just from the central bank perspective, the Bank of Canada’s raising interest rates to slow inflation, but that's only going to happen if you have a decline in economic activity or a reduction of the growth in economic activity, and that entails pain. There's no other way to put it. It could be a little pain or a lot of pain, depending on the strength of job market, balance sheets, other things. But that pain is inevitable. So, you go through a period of weakness, some things are going to hurt certain types of individuals more than others. Recessions, we know, for instance, are more harmful for folks at the lower end of the income stream than the higher end of the income stream. They're more harmful for folks that are in the private sector versus the public sector. So, there’s a range of things going on as well. But nobody wants to go through a recession, no question about it.
SM: Right. You talked about psychology and how that can impact, you know, whether a recession even happens or not because their expectations affect their behaviour. Does that suggest also sort of a difference between like technically having a recession and a ‘felt recession?’ I mean, what individuals consider to be the reality today, regardless of what C.D. Howe or somebody else might say?
JFP: Probably. And again, the reality is that takes a long time for us to get economic data to confirm a recession or not. Even if it's just GDP. Quarterly GDP you get a few months after the quarter's over. Now, if you're looking for two quarters negative growth, you're going to get confirmation of that several months after people have done whatever it is that they've done that has led to, say, the negative outcome. So, you kind of always get ex-post confirmation there was a recession. You never get a real time assessment of it. Now that might be changing as we’ve got access to better data now than we have in the past. Certainly, that's how statisticians are evaluating the economy now, or they will in the next several months. So, the talk of recession and how people respond to that impacts behaviour now. Will impact it in January, February, March. But we're not really going to know until much later on if there has actually been a recession. So, to some extent, you can talk about a recession, but people they don't know. It's just, you know, they listen to folks like us, they’re reading the news. Trying to make their own view as to whether or not the economy is strong, if they're stable, should you be thinking about their finances differently? Should firms be thinking about investment or spending decisions differently? And they do that not knowing whether or not there actually is a recession because you only find out quite a bit later on.
SM: I guess recessions are just part of the economic cycle. Should people just expect every what, every ten or 15 years these just happen?
JFP: Yeah. I mean, there's no set cycle for recessions, obviously. But usually recessions occur when things have been going well for a very long period of time. And you get into a situation where economies are running too hot, right? There's too much inflation. Firms are run out of ideas for investments. You've run out of workers. You've gotten to a point where it just becomes very difficult to grow in a non-inflationary way. So, the economy needs to adjust. Usually, it’s a central bank that kind of triggers that adjustment raising interest rates. But that's normal, right? You know, central bankers, they're not magicians. Like they can't set policy in a way that everything is always perfect all the time. They can't. There are cycles. And one of the consequences of there being cycles is once in a while you have a downward economic adjustment, a recession or otherwise. It doesn't have to be recession, it just can be weak growth. But those are necessary once in a while.
SM: Right. Okay, so if we were to have a recession next year, what can governments do to help people or businesses? And I guess from your perspective, what should they do or what should they not do?
JFP: So that's a really tricky thing. And what we're seeing around the world is that policymakers seem to be more in the camp of making mistakes in terms of managing the current situation as opposed to facilitating it. And to understand that, you just basically have to think of what the original driver of the recession is in say Canada in the U.S., which is inflation is a problem, we're trying to slow growth, to slow inflation. The trigger for the recession, if you will, is inflation. Now, normally, when governments approach a period of cyclical weakness, you have central banks that cut interest rates and have governments that spend a little bit more. EI payments or infrastructure or in the pandemic, they give cheques to people. Those are designed to protect people from the worst impacts of a recession. In the current environment, inflation is extremely high. The central bank is moving to slow the economy, to bring inflation down. Policies that are designed to forestall a recession. Or policies that make it more difficult for the Bank of Canada to achieve its inflation objective, are probably raising the risk of recession. Because it means the Bank of Canada has to do more. As well intentioned as these policies might be. The reality is that you've got to take a little bit of steam out of the economy, and if you try to provide support, if you try to slow the adjustment by being generous in terms of fiscal policy, you are making the job of inflation control harder. Could be a little bit harder, it could be a lot harder, it depends on what you're doing. And that's running counter to what the central banks are trying to achieve. So, you actually, at the margin, maybe are increasing the risk of recession in your hope of preventing a recession in some sense.
SM: Right. Of course. Okay. Last question. If we have a recession, we don't know whether we will. If we have a recession, will we have a so-called soft landing?
JFP: That's the hope. Now I think that's achievable in Canada for some reasons we talked about. Balance sheets are still reasonably strong, with the job market still very, very strong. We don't see a recession occurring in Canada on the basis of what we think the Bank of Canada is going to do, on the basis of our assessment of kind of the macro fundamentals. We see that being more likely by virtue of, say, what's happening in the U.S. or what will happen in the U.S. or how the situation in Britain unfolds and how that impacts markets and sentiment. And because that would mean that the recession is occurring for reasons that are a little bit beyond our control, it becomes very difficult to achieve a soft landing. We don't think it'll be a hard recession, nevertheless. But to some extent, we're hostage to some of these things that are occurring outside of our borders. And that makes it harder to control.
SM: All right. Well, I think we will leave it there. Thanks as always for coming in, JF. Really appreciate it.
JFP: Well, thanks, Steve.
SM: I've been speaking with Jean-François Perrault, Chief Economist at Scotiabank.