Where are We?

Assessing the current phase of the business cycle

20 years ago this week, Lost premiered. Like the character, Charlie, who asks—“Guys, where are we?”—at the end the premiere episode, it is easy to be confused about where we might currently be on the business cycle.  

Today, for example, the Bureau of Economic Analysis (BEA) released data on disposable income, consumer spending, and the consumer expenditure price index. The data continue to support the assessment that the macroeconomy is stable, an assessment reiterated in many previous posts by this blog. As of today, too, the “GDPNow” forecast provided by the Atlanta Federal Reserve Bank predicts real GDP for the 3^rd quarter (which technically ends on Monday) will be 3.1 percent.

Yet, in spite of positive macroeconomic data, there is never a shortage of pessimism or confusion on the state of our macroeconomy. Part of the issue may be the fact that, unless things are so bad that it is absolutely obvious that we are in a recession, we are really never sure which part of the business cycle we may currently be riding.¹ Are we slowing down? Or about to heat up? Is a recession looming or already upon us? And so on.

Adding to the potential confusion is that it is not clear how to describe or even define parts of the business cycle. Motivated by actor Dominic Monaghan-as-Charlie’s iconic line, let’s take a look into it.

The Guts of the Business Cycle

In the post Anatomy of the Business Cycle, Macrosight stuck with simplest view of the business cycle—we oscillate between expansions and recessions. Yet, labeling only two parts of the business cycle is probably too simplistic. Figure 1, for example, identifies three additional phases, for a total of five.

In Anatomy of the Business Cycle, Macrosight noted that a recession is defined as the part of the business cycle from the peak of a cycle to the next closest trough. Then, from the trough to the next peak is the expansion (that is how the NBER dates past recessions and expansions).

However, defining the business cycle in such a way is a bit too simple. Instead, we can think of the business cycle as made up of multiple phases of which “recession” and “expansion” are part.

Here I list five sections of the business cycle—recession, recovery, recovery-to-early expansion, expansion, and late-expansion-to-slowdown. And, it would be reasonable for someone to make a list that includes even more sub-phases, perhaps labeling a late-expansion as distinct from a slowdown. Or, drawing a firmer line between recovery and early-expansion.

The reason I list “only” five is because it is difficult to not only identify the phases, but to say when one ends or another begins (it is analogous to identifying “micro-climates” within a broader area of weather patterns).

Then, even if we have correctly identified and labeled the phases, it is not clear which phase we are in at any given moment. For example, let’s consider some possibilities about the current state of our macroeconomy:

1. Expansion: Since real GDP has been growing around 3 percent for most of this year, the unemployment rate is still below the non-cyclical rate, and the rate of inflation has been stable, we could claim that we are currently in a good-ole’ fashioned “expansion.”

2. Late-Expansion/Slowdown: But, since the rate of inflation has been declining (or disinflating), and the rate of unemployment has increased over the last few months, both facts may imply that we are in the “late-expansion-slowdown” phase. The fact that the Fed cut its target interest rate by 50 basis points last week suggest they think we are in more of a slowdown phase than in an expansion.

3. Recovery/Early-Expansion: From the first quarter of 2022 through the second quarter of 2023, real GDP growth averaged 1.1 percent. From the 3rd quarter of 2023 through the second quarter of this year, it has averaged 3.1 percent. So perhaps the past four quarters—on the heels of those anemic quarters—signals more of a recovery phase. That is possible, but I doubt it. The typical “rule-of-thumb” is that as the economy heats up, so does the rate of inflation. But that has been declining. And, in an early-expansion, we wouldn’t expect the unemployment rate to tick up, as it has this past summer.

4. Recession: No. We are not in a recession, not with a year’s worth of real GDP growth averaging 3 percent.² If we find ourselves arguing that such a relatively high rate of growth is consistent with a recession, that would imply the goal posts had shifted to a ridiculous extent, far enough that macroeconomic discourse, much like seasons five and six of Lost, would have completely jumped the shark.

In addition to the business-cycle uncertainties already mentioned, part of the challenge in nailing down which phase we are in is the fact that no two “cycles” are the same. Every recession and expansion in history have been different. Consider, for example, the Great Recession and the Covid-19 Recession.³

Great Recession vs. Covid-19 Recession

Figure 2 displays a measure of the business cycle from 2005 through the second quarter of this year (the most recent published estimate for GDP). The measure of the business cycle is the “output gap," calculated as the difference between real GDP and Potential GDP (both measured in 2017 constant dollars—Macrosight explained Potential GDP here, and discussed this version of the gap here).⁴ The Great Recession is dated from 2007Q4 to 2009Q2, and the Covid-19 Recession is dated as spanning the first two quarters of 2020.⁵ The two recessions are shaded in red, with the five phases of the business cycle annotated on the figure.

The contrast between the Great Recession and the Covid-19 Recession provides a useful illustration of the irregularity of the business cycle, and how difficult it is to define when one phase ends and another begins. Here are a couple things to notice about these two recessions:

1. The recession phase of the Great Recession is dated as lasting for seven quarters. Yet, the recovery phase implies the pain of that recession lasted much longer. The output gap remained negative for a number of years after the second quarter of 2009 and, in fact, only reached a positive value very late in the 2010s.

2. The cycle that contained the Covid-19 Recession, on the other hand, followed a very different path. The recession phase itself was very short, yet the size of the negative output gap was dramatic. The recovery-into-an expansion, however, was swift. The output gap became positive again in the third quarter of 2021, went negative in 2022, but rebounded in mid-2023.

The contrast between the Great Recession and the Covid-19 Recession also illustrates how, with the exception of the trough, the transition from one phase to the next is difficult to pinpoint exactly. Once we are beyond the trough, for example, it is difficult to say when a recovery ends and an expansion begins. Hence, we hedge a little by using the terms like “early” or “late” expansion. One might, for example, label the entirety of the 2010s as a recovery, though on Figure 2 I have labeled the last few years as constituting at least part of an expansion.

We are here

The uncertainty of the business cycle is a primary reason the Fed meets every seven-to-eight weeks. This uncertainty is also the reason we, and the Fed themselves, never can be sure what policy decision they will make until the actual meeting. This uncertainty, too, also gives anyone license to opine about what is coming next, whether they be a recession-is-always-coming dooms-day’er, or someone a bit more optimistic, like yours truly.

1. Over the past 35’ish years we have had four recessions—in 1991, 2001, 2007-2009, and in 2020. Since 1945, as dated by the NBER, expansions have lasted an average of about five years (64 months or 21 quarters), while recessions have lasted an average of less than a year (just over three quarters or about 10 months).

2. Recall, real GDP growth barely averaged 2.0 percent over the two-decades prior to Covid-19.

3. Unlike the “Great Recession,” which is a commonly-used label for the 2007 to 2009 recession, “Covid-19 Recession” is not necessarily the conventionally-accepted label for the 2020 recession. However, it is what I am going with.

4. The “output gap” can also be conceived in terms of percentage deviation. That is, as the difference between the growth rate of real GDP and the growth rate (or some average growth rate) of Potential GDP.

5. As dated by National Bureau of Economic Research’s “Business Cycle Dating Committee.” This committee defines a recession as lasting from peak to trough, and an expansion as lasting from trough to peak. To choose when those turning points occurred, the committee considers a number of factors when dating the business cycle (see here for details), and they do so, typically, well after the fact since the troughs and the peaks are only obvious in hindsight.