When the definition of a recession matters

The official definition of a recession in nearly all developed economies except the US is two consecutive quarters of negative growth. In the US a recession is ‘called’ by the NBER. Economists, of course, just look at the numbers. This is obviously the sensible thing to do, because a fall in GDP of 3% followed by positive growth of 0.1% is clearly worse than two periods of -0.1% growth, but only the latter is an official recession. The media on the other hand behaves differently, so we had the silly situation in the UK before 2013 when tiny revisions to GDP led to headlines like ‘UK avoids double dip recession’.

Yet this minor annoyance for people like me has been turned into an opportunity in a recent paper (pdf) by two political scientists at the LSE (HT David Rueda). Andrew Eggers and Alexander Fouirnaies look at the data to see if the announcement of a recession causes any additional impact on macroeconomic aggregates compared to what you might expect from the GDP data itself. In other words, does the announcement of a recession reduce consumption or investment in OECD countries, conditional on actual economic fundamentals? For ease I’ll call this an announcement effect.

For investment they get the answer that economists would hope for - there is no announcement effect. Firms are well informed, and just look at the numbers. However for consumption they do find a significant announcement effect, both in terms of the actual data (and the size of the impact can be non-trivial) and in terms of consumer confidence indicators. One final result they emphasise, which makes clear sense from a macro point of view, is that the impact of recession announcements on consumer spending in smaller in countries with more robust social safety nets.

There are many reasons why this is interesting, but let me focus on one that I have discussed before. In this post I pointed to a potential paradox. On the one hand I believe that for most macroeconomic problems, rational expectations rather than naive expectations is the right place to start. On the other hand I also think that media reporting can have a strong influence on the average persons view on certain highly politicised issues, like is man-made climate change a serious problem, or how important is the cost of welfare fraud. I discussed this paradox here, and argued that it could easily be resolved by thinking about the costs and benefits of obtaining information. In particular, the costs of researching climate change are significant, whereas the cost to the individual of getting their own view wrong is almost zero. (This is just a variation on the paradox of voting.)

In the example from this paper, we have a standard macroeconomic problem, which is trying to assess what level of consumption to choose. The importance of the announcement effect suggests that for consumers the costs of ‘looking at the numbers’ (and, of course, interpreting them) to some extent exceeds the benefits of going beyond media headlines. If the media can have an influence on something that clearly has a significant financial pay-off for individuals, then it is bound to influence attitudes when the personal costs of making mistakes is almost zero.