ExplainSpeaking | Is US undergoing a ‘growth recession’?: Meaning and origins

CHART 1 shows how two of the key benchmark indices in the US — namely the S&P 500 and the Nasdaq 100 — have registered quite remarkable gains over just the past six months.

Why is the rise in US stock indices surprising?

What makes these gains in US stock markets stand out is the fact that at the start of 2023 it was almost a foregone conclusion among most experts and analysts that the US, which is the world’s largest economy, as well as the other developed economies would experience recession.

US stock indices over the last six months. (Source: Google Finance)

In common parlance, a recession implies that the total economic activity in an economy contracts for two consecutive quarters. In other words, if an economy’s GDP in the first three months of the year (first quarter) is lower than what it was in the first quarter of last year and the same thing happens in the second quarter, then the economy is said to have gone into a recession.

A big reason for such fears was the action of central banks in the US and Europe. Faced with historic inflation, central bankers were rapidly raising interest rates to bring down economic activity and cool down inflation.

Typically, during such phases, stock markets tend to suffer. That’s for two reasons.

One, if interest rates are moving up, an investor feels less inclined to invest money in the riskier stock markets when they can earn more by just keeping it in the bank.

Two, a slowing economy essentially means more unemployment, lower consumption levels (read demand for goods and services) and, consequently, lower profitability of companies. That, in turn, reduces the incentive to lend to these companies by investing in the stock markets.

And yet, as the CHART above shows, US stock markets seem to have soared, suggesting investors are quite optimistic about the future.

What explains the gain in US stock markets?

There are many ways in which different experts are rationalising what is happening.

Some are betting that the US economy will falter and as it does, the stock markets will come off these heights.

But there are others who have suggested a more nuanced explanation: That the US is growing through a “growth recession”.

In other words, they expect the US may avoid a full-blown recession. This is another way of saying that the US economy may have a “soft-landing” as against a crash of recession.

But what exactly is a ‘growth recession’?

Speaking to Bloomberg recently, Anthony Crescenzi, the executive vice president of a noted investment firm PIMCO, said: “The US is in a growth recession today. Growth recession is something above zero but below potential”.

What Crescenzi meant was that instead of the US GDP growth crashing and contracting, it has slowed down to a level significantly below its potential. For instance, for the US the potential GDP growth rate according to Crescenzi is 1.8%. In 2022, the US grew by 1% and in 2023, he expects it to grow even lower.

But crucially, instead of contracting below the 2021 level, the US GDP continued to grow in 2022. The same is likely to happen in 2023.

Of course, the eventual GDP growth rate is likely to be well below the potential GDP growth rate.

What is the potential GDP growth rate of an economy?

To be sure, the potential GDP growth rate is that rate of growth at which an economy can grow without spiking inflation.

“US has the potential to grow (its GDP) by 1.8% each year. It is a combination of (increased) productivity (accounting for 1.5%) and changes in labour force (accounting for the remaining 0.3%)

Why is it called a recession if it involves growth?

The phrase “growth recession” was coined by American economist Solomon Fabricant in a 1972 paper titled “The ‘recession’ of 1969-1970” and published by NBER (National Bureau of Economic Research).

By the way, NBER is the organisation in the US that is authorised to declare whether the US economy has gone into a recession or not. To be sure, it doesn’t limit its definition to just GDP contraction; it looks at other indicators such as unemployment as well as the depth and spread of economic troubles.

In the paper, Fabricant was trying to understand what happened to the US economy in 1969 and 1970.

Fabricant started his paper as follows:

“There can be no doubt that economic expansion came to a halt in the United States in the Autumn of 1969. What has been in question is this: Did the halt mark a pause in the expansion, or did it mark a peak in the business cycle and the onset of a recession? The quotation marks in the title of this paper are intended to put the reader on prompt notice that no plain yes-or-no answer to the question can be given.”

The fact is, as Fabricant also underscored, “the word recession means different things to different people. Not everyone has in mind the National Bureau’s definition. But even that, as was recognised from the start, has its ragged edges.”

In other words, there are times when it may not be a recession but it feels like one.

“A tiger caged is not the same as a tiger loose in the streets, but neither is it a paper tiger. There are good reasons for not forgetting that important fact,” he wrote.

For instance, a key marker of recession is the rise of joblessness or unemployment. But what if, an economy grows at such a pace — or such a way — that there is rising unemployment?

Technically, it may not be possible to categorise such an economy to be undergoing a “recession” but its constituents do feel almost equally bad.

It is for those times that Fabricant coined the phrase “growth recession”.

Is it happening in India as well?

At first glance, India doesn’t seem to be undergoing whatever US is going through. However, here are some key facts about the Indian economy that are noteworthy.

India’s potential GDP growth rate has been sliding since the Global Financial Crisis of 2009. It used to be 8% during the high growth phase of 2004-2009. Since then it has been coming down in a secular fashion and had fallen to just 6% by 2019, just before the pandemic hit the economy.

India’s GDP growth decelerated sharply between 2016-17 and 2019-20. In fact, it grew at less than 4% in 2019-20 –well below its potential GDP growth rate of 6% at that time. This was also the phase when unemployment levels, even by the government’s own admission, breached a 45-year record. Consumption levels faltered as well — for the first time in India’s history — but that official survey and its findings were disregarded by the government.

Coming out of the pandemic, India’s economy has grown much faster and given India the mantle of the world’s fastest growing major economy.

However, the following few trends also exist alongside.

One, a big reason why India seems to have grown faster in the last two financial years has been the effect of a low base, thanks to the Covid-induced contraction in 2020.

Two, growth rates have started decelerating yet again. From 9.2% in FY22 to 7.2% in FY23 to likely around 6% in the current financial year.

Three, no matter what metric one looks at — unemployment rate, employment rate or labour force participation rate — the stress in the labour market is undeniable.

Four, consumption levels of average Indians have largely remained muted and this is not only borne by the official GDP data but also by the fact that companies have held back from aggressively ramping up fresh investments.

Share your views and queries at udit.misra@expressindia.com

Until next time,

Udit