The Counting Heads Theory of Recessions

Current headline on CNN.com:  "Three-quarters think US in recession"    Can you imagine either of the following two headlines ever appearing?

"Three-quarters think Swayze X-ray shows pancreatic cancer"

"Three-quarters think the barometric pressure is falling"

We may well be in a recession, but if one accepts the common definition (with all of its problems) as negative GDP growth, we aren't going to know that until sometime next month at the earliest, when the data is in and is interpreted.  In the meantime, what possible difference does it make whether or not people "think" we're in a recession?  Of course headlines such as that might well have a feedback effect on expectations, which could indeed slow growth and trigger or deepen a recession. 

Ever get the feeling that the media are rooting for a recession as big stories  of bad times sell a lot better than the myriad little good stories that comprise the results of accumulated 2% annual growth?

Update 3/21 at 2:30pm - current headline at CNN.com:  "Americans confident in '09 turnaround."  Sigh.

Comments

[matthew mueller]

Austrian economists, like Professors M. Skousen and J. Huerta de Soto, have made convincing cases for why GDP measurements should be abandoned. Anyone who takes the Austrian theory of capital seriously should be very sceptical of the conventional tools economists use in "interpreting" data. As Skousen put it, there is nothing about GDP figures that suggests it measures the economy in "gross" terms; the capital structure is completely ignored, leading many economists to argue incorrectly that consumption spending constitutes 70% of our economic activity and that we should above all else try to stimulate spending by consumers.

I think expectations play a far greater role in economic activity than is hinted at in Dr. Horwitz's post. One can try to graft expectations onto the loanable funds market and argue that interest rate targeting distorts "real market signals", but I think this argument is mistaken (see Feb. 19 "Is Buffet a Misesian" on this blog).

Expectations determine the degree to which the demand for liquidity spreads throughout the economy, directly impacting the level of interest rates as bond and wealth holders scramble to re-arrange their portfolios in response to current market conditions and, no less important, current expectations about future market conditions.

[Steven Horwitz]

Matthew:

Mark Skousen's case for getting rid of GDP is an utter and complete embarrassment to Austrian economics. Having seen him present his argument at a FEE seminar a few years ago and promptly be intellectually destroyed by the graduate students there, I can vouch for its inanity. Citing Skousen on this issue will get you little credibility. Furthermore, I noted the problems with conventional measures of recession in the post.

And... your points about expectations might well be right, but you are criticizing me for not presenting a full-blown theory of recessions in what amounted to a snarky post about the media. Not really fair, I'd say.

[matthew mueller]

Dr. Horwitz,

I did not realize that Skousen's attack on conventional GDP measures was regarded as "inane" by many Austrians. I only know what books tell me. Because Huerta de Soto picked up the point in his book, I thought it was considered valid by many Austrians. If you decide to respond (which I hope you do), could you please include a sentence explaining why Skousen's critique is not correct?

And about expectations. Consider this post a continuation of the earlier discussion we had here: http://austrianeconomists.typepad.com/weblog/2008/02/is-buffet-a-mis.html

Although your "theory of recessions" cannot be found in this post, I think I am familiar with it. I finished reading the exchange you had with Greg Hill in Critical Review not too long ago concerning recessions and investment, and think Greg Hill made some remarkably perceptive points. I think more Austrians should pick up his work. His exchanges with Bruce Caldwell are equally fascinating.

[Grant]

Insofar as markets and not democracy control financial markets, I don't think the publics' expectations of recessions is very important to their performance. It seems to me that its the opinions of the professionals who actually work in the markets that matter.

I do think we have a proper tool for the job here:
http://www.intrade.com

[Steven Horwitz]

To be honest Matt, it was so long ago that I can't remember enough of the details of MS's argument to reconstruct it here. To the best of my memory, his alternative measure of growth was full of double-counting errors that the grad students and faculty immediately pressed him on and to which he had no convincing response.

[DPrychitko]

One quip, Steve. A decline in real GDP is no longer the "common" definition of a recession. In the past decade the most commonly used is:

"a decline in real GDP *or* a decline in the rate of growth of real GDP."

Hence how often we have been on the brink of or in a recession lately.

[Steven Horwitz]

Heh - yes indeed, "slowing growth" becomes the equivalent of "negative growth". Taking your foot off the gas is the same thing as putting the car in reverse, I guess.

[matthew mueller]

Dr. Horwitz,

I hate to press this point, but I am curious. Would you then agree that consumption spending occupies 70% of total spending, as conventional GDP measures state? It is on this point that led me to find Skousen's argument so persuasive. The capital structure of an industrialized economy is too pervasive and complex to allow consumptiong spending to dominate economic activity.

Now I could see why students trained in neoclassical economics would disagree with Skousen's argument, but those familiar with Austrian capital theory should at least be willing to take it seriously.

[Steven Horwitz]

Matt,

These were AUSTRIAN grad students and AUSTRIAN faculty who tore his alternative measure of economic growth apart.

[Brian Pitt]

Dr. Horowitz,

Great post. I think that you may slightly underestimate the importance of survey data though. While this is an empirical question, I will bet that, if someone were to plumb through the SAEE, it will show that if respondents believe that a recession is extent, negative feedback was soon to follow.

[Logan Boettcher]

Is George Reisman's concept of gross domestic revenue (http://www.mises.org/story/2878) the same as Skousen's, or is it a more thought out approach? I'll take the responses off the air. Thanks.

[Sven]

Matt,

Your curiousity about economics should be applauded. However, your interpretation is often a little bit off-kilter. Are you a grad student?

Sven

[matthew mueller]

Sven,

I am still an undergraduate (in my third year). Maybe that is why my interpretation is a bit off-kilter?

[Stefan Karlsson]

As I've written here, real GDP declined already in Q4 2007 when adjusted for terms of trade effects as nominal GDP increased 3.2% while the domestic demand deflator rose 3.8%(since then both numbers have been upwardly revised by 0.1%:points, leaving the real number unchanged).

http://stefanmikarlsson.blogspot.com/2008/01/us-real-gdp-growth-turns-negative.html

The NBER:s alternative definition based on the Conference board's coincident indicators of nonfarm payroll employment, real disposable income excluding transfer payments, industrial production and real business sales also show that
economic activity peaked in October and has declined since then.

http://www.conference-board.org/pdf_free/economics/bci/LEI0308.pdf