A recession is generally defined as two consecutive quarters of decline in a country’s real GDP. However, identifying a recession involves looking at various economic indicators, not just GDP. Economists and analysts monitor several key metrics to gauge the health of the economy and determine if a recession may be imminent or already underway.
GDP Growth
Gross domestic product (GDP) measures the monetary value of all goods and services produced in a country over a specific time period. It is the broadest measure of economic activity and growth. A decline in real GDP (which excludes the effects of inflation) over two or more consecutive quarters meets the traditional definition of a recession.
However, GDP is released quarterly, so by the time two declines have occurred, the recession is likely already underway. For this reason, economists look at various monthly and weekly indicators that can signal a downturn in economic activity and growth earlier than the official GDP reports.
Unemployment
The unemployment rate measures the percentage of the labor force that is out of work. It is released monthly based on a survey of households. Unemployment is considered a lagging indicator, meaning it tends to rise after a recession has already started, rather than signaling one ahead of time.
However, a rising unemployment rate shows that companies are reducing their workforces, cutting back on hiring, and laying off workers. This signals declining business conditions and economic activity. A high or rapidly rising unemployment rate is a warning sign of trouble for the economy.
| Month | Unemployment Rate |
|---|---|
| January | 4.0% |
| February | 4.1% |
| March | 4.2% |
| April | 4.3% |
| May | 4.5% |
| June | 4.7% |
In this hypothetical example, the steady increase in the unemployment rate over a 6-month period is a warning sign that the economy may be entering a recession.
Manufacturing Activity
The health of the manufacturing sector is another indicator to monitor for signs of economic slowdown. Manufacturing typically weakens earlier than the broader economy because factories reduce production and output at the first signs of slowing demand.
Surveys of purchasing managers like the Institute for Supply Management’s PMI index can provide insight into manufacturing sector performance. A PMI reading above 50 indicates expansion, while a reading below 50 signals contraction. Three consecutive months of declining PMI figures can foreshadow a recession.
| Month | PMI Index |
|---|---|
| January | 52 |
| February | 51 |
| March | 50 |
| April | 49 |
| May | 48 |
| June | 47 |
In this example, the downward trend in the PMI indicates declining manufacturing activity, orders, and production. This signals an economy that is heading toward recession.
Housing Starts
Housing starts measure the number of new residential construction projects that have begun in a given month. This includes construction of single-family homes, townhomes, condos and apartment buildings. Housing starts are an important indicator of activity in the housing sector and the overall state of the economy.
In a healthy economy, housing starts will be increasing steadily. However, in times of economic uncertainty or recession, there is less demand for homes, causing a decline in housing starts. A sharp drop or prolonged slump can signify shrinking economic output and growth.
| Month | Housing Starts |
|---|---|
| January | 1,500,000 |
| February | 1,450,000 |
| March | 1,400,000 |
| April | 1,300,000 |
| May | 1,200,000 |
| June | 1,100,000 |
The steady decline in housing starts shown here signals waning demand in the housing market and a potential economic slowdown on the horizon.
Other Leading Indicators
In addition to the major metrics discussed above, there are several other leading economic indicators that analysts monitor for signs of recession:
- Interest rates – An inverted yield curve when short-term rates rise above long-term rates can signal recession 12-18 months ahead.
- Consumer sentiment – Declining consumer confidence and expectations about the economy’s outlook based on surveys.
- Retail sales – Falling retail sales signal reduced consumer spending and economic growth.
- Business investment – Decreasing capital expenditures by companies indicate pessimism and antedate recessions.
- Commodities – Slumping prices for raw materials like oil, copper, lumber signal weak global demand.
- Stock market – A falling stock market can precede a recession by 6-12 months.
Conclusion
Economists analyze a wide range of monthly, weekly, and daily indicators to determine the likelihood of a recession. GDP is a lagging indicator, only showing contraction has begun after the fact. Leading indicators like unemployment, manufacturing surveys, housing starts and others can show vulnerability in the economy before a downturn actually starts.
However, no single indicator is definitive. Experts look at the overall balance of signals from multiple indicators to judge recession risk. A cluster of negative data points foreshadows a high probability of recession, especially when indicators from multiple sectors of the economy agree.