In the BBC newsfeed this morning:

Eurozone recession continues into sixth quarter.

The headline made me think about how most of us know the words “recession” and “depression” as interchangeable jargon used by the business news anchor. Also: “contraction”.

It’s the kind of language that floats ominously around the TV room while you’re tweeting an instagrammed photo of the cup of hot chocolate that you just made. And maybe I should try it with that vintage filter. And if I just fiddle with this light/dark thingie… Perfect. Looks retro but not like I tried too much. Send. Oh. The business news. Where’s the remote? 

And then you flip over to The Good Wife where you watch Diane Lockhart announce that “this economy is about to enter a triple dip recession”… And even as Christine Baranski layers her character’s line with hushed seriousness, you can see her eyes glaze over and the proverbial blank speech bubble popping up on the side of her head.

But before we can get to recessions, depressions, contractions and triple dips, I need to backtrack a bit by asking the fundamental questions. Starting with:

What is an Economy anyway?

This question is a bit like asking “why is water wet?” – we may know what it is empirically; but theoretically, it’s complicated.

If you look at the root of the word “economy”, it derives from the Ancient Greek word for “household management*”. Which gives a great starting point: because any household more or less functions as an semi-independent ecosystem:
*For those interested in the etymology, the word is “οικονομία” – which is in turn derived from “οíκος” (household) and the verb “νεμω” (I manage).

  • the household has land, shelter and the skills of its members (natural resources),
  • which are used and/or manipulated to meet the needs of the household members.
  • When there is a need that cannot be met internally, then the household either engages in trade with other households, steals what they need, or goes without.

And an “economy” – as we understand it – is more of a collective noun for all of the households (micro-economies) contained within a geographical region (the macro-economy).

But even if we know what it is, this leads to an even more difficult question. That is: how do you know if a economy is a good one? Some options (and I’m sticking with the household analogy):

  • Should we look at the amount of land, shelter and skills that it has? But that’s not really a reflection of how the household is doing – just what it has. And they may not be doing very much with it (in macroeconomic terms: “the economy’s natural resources“)
  • Do we look at how much all the members are eating, drinking and generally using? Well that sounds a bit better – because if they’re doing stuff, then they must be using their resources and/or trading to get it. Although…they could be borrowing food from another household. Or, as I said before, stealing it. (in macroeconomic terms: this is “total consumption“)
  • So then, should we look at how much “stuff” is being produced by the household? That sounds even better. Because now we’re looking at how well the members are taking what they have (their resources) and turning it into stuff that can be consumed or traded. But if we just look at what they’re producing, that may include the production of things that they don’t need. And which might be a waste. I mean – how many needlepoint cushion covers can one family really use? (in macroeconomic terms: this measurement is “gross domestic product“)
  • Or maybe we should abandon a physical measure, and try to measure how happy the household is? Surely that’s what really matters? Maybe. But I dare you to try measure it. (in macroeconomic terms: there is therefore no term for it)
  • Alright, so we’re back to the whole GDP (gross domestic product) situation.

Gross Domestic Product (GDP)

GDP is the least of the measurement evils: we look at how much an economy is producing as an indicator of how well that economy is doing. Of course, there are some problems with it:

  1. Relative Value: how do you value everything? Is it at the cost to produce or at the price you could sell it for? And what about the currency you use? And more importantly, as discussed in the post on Bus Driver Conundrums – the “value” of the same services in India and Sweden are different. So when we do ascribe a value, we should be worried about comparing fruit with fruit…*
    *It’s why GDP is normally quoted two ways: once in US dollar terms, and once in “Purchasing Power Parity” terms – meaning that the GDP number is adjusted to reflect the fact that you can buy more for $1 in South Africa than in France.
  2. Wastage: or what an Austrian economist would call “malinvestment“. Most people have heard of John Maynard Keynes telling the British government during the Great Depression to pay people to dig holes, refill them, then dig them again – anything to get them paid so that they would go out and spend their salaries, thereby kick-starting the nation back into more useful activities. But should Britain really have included “number of holes filled” as part of their Gross Domestic Product? Does that seem like a reasonable assessment of the situation?*
    *Most economists just ignore this. Part of the justification might involve: “if too much of a product is produced, then its price will go down, so we’ll get an accurate reflection”. Which is fine, unless you have a government determining the price of holes artificially… And/or you have a population that wants every person to own four houses on the premise that they can rent them out. But, like, to whom? 
  3. Logistics: how, in the name of all that’s holy, does one just collect the information on all these households?*
    *Clever people making estimates do a lot of the work. As does the Tax Collection Authority…

But let’s just accept that we can address some of those problems and come up with a reasonably reliable estimate of GDP. At that point, we can start comparing the change of GDP from year to year. And when a country produces more, it’s experiencing economic growth (AKA a boom period); and when it produces less, there is economic decline (AKA a bust period).

But this is all highly relative to time. For example – an economy naturally produces less in January – because people are still getting back from Christmas leave. Would we say that the economy just went through a bust period?

Seems a little extreme…

How Long is a Piece of Bad Time

Economists love to agree on conventions – especially in relation to time. And then, of course, disagree about whether the convention is appropriate.

But that aside – clearly, looking at GDP movements month-on-month is subject to seasonal distortions (like a strong Christmas period in December, followed by a slow month in January). So to smooth out those impacts, economists will talk about quarterly movements in GDP.

When GDP decreases from one quarter to the next, this is known as a “contraction“. But again – this need not necessarily be something dismal. If a country is very agricultural, the harvest Quarter will usually be splendid in GDP terms – followed by a less productive winter Quarter (ie. the economy undergoes a natural contraction).

But if an economy contracts for more than two quarters*, that’s beginning to look less normal. After two quarters of negative growth, it is generally accepted that the economy is experiencing a “recession“. And in turn, a “depression” is usually declared when an economy has been in recession for longer than two years.
*The quarters: Q1 = Jan, Feb, Mar; Q2 = Apr, May, Jun; Q3 = Jul, Aug, Sept; Q4 = Oct, Nov, Dec.

Now obviously, there are some interesting variations (or distortions!) that can take place. Let’s say that you have two really bad quarters (Q2 and Q3), but things recover a bit in Q4 because of Christmas spend and bonuses. But it was just a short term thing, so you go back into two even worse quarters (Q1 and Q2) of the following year. You’re now in a “double dip recession“. And if that cycle repeats itself, you can end up with ever increasing multiples of dips.

But I don’t think I can overemphasize how unusual it is for an economy to contract quarter in and quarter out for quarters on end. We’re not just talking about a “bad time” – because when you’re in a “bad time”, you expect to hit the bottom of the barrel, and then improve relative to the bottom of the barrel. It’s the problem with the phrase “recession” – it implies that you’re just in a funk, lazing around and refusing to get out of your pyjamas.

This headline up top – it’s the Eurozone getting progressively worse as the quarters go by. To extend the metaphor, the lazing around caused bedsores, which then started to smell, which attracted the rats, which drove away your mother, which stopped the chicken soup from being delivered.

If the cycle continues, Europe may end up in a depression. And at that point, the concern is that the atrophy will leave her trapped in the house indefinitely.

That headline is terrifying.

But try not to worry too much.

*goes back to tweeting his support for Angelina and her pre-emptive double mastectomy*