Are Recessions About Employment?

I’d say yes, but Nick Rowe disagrees. He recently tweeted an old post from 2015, which ends as follows:

Recessions are not about output and employment and saving and investment and borrowing and lending and interest rates and time and uncertainty. The only essential things are a decline in monetary exchange caused by an excess demand for the medium of exchange. Everything else is just embroidery.

First I’m going to tell you why I disagree, and then I’ll explain why my disagreement is not very important, at least for the US economy.

I don’t believe that terms like “monetary exchange” and “excess demand” are clearly defined. In my view, the most useful definition of a recession is a slowdown in employment growth that is sudden, significant and in some sense “anomalous”. By that, I mean a slowdown in employment growth that seems unrelated to fundamental factors such as demographics or preferences.

As this graph shows, slowdowns in employment growth are extremely strongly correlated with “recessions”, as defined by the NBER. (The end of WWII was a bit weird. But that was an unusual period, with women entering the labor force during the war, then leaving, and soldiers returning home.)

Screen Shot 2019-01-20 at 4.42.40 PM

Thus in an accounting sense, recessions are mostly about employment, not factors such as productivity. And most economists believe the reduction in employment during recessions is non-optimal, that it does not reflect preferences. So what causes this slowdown?

In my view (and I think Nick agrees), these recessions are caused by sharp declines in NGDP growth in an economy with sticky wages and prices.  Here is some data on NGDP growth:

Screen Shot 2019-01-20 at 4.39.07 PM

Once again, the correlation is quite strong. At the same time, I could easily imagine other factors causing a recession. A government might institute an extremely high minimum wage rate, and then later remove this wage floor. This would temporarily depress employment growth, without impacting NGDP. So I don’t see how recessions can always be caused by an excess demand for money unless they are defined that way. But since we cannot directly measure excess money demand, that’s not a useful definition. All we can do is look at various macro variables and infer that there was an excess demand for money.

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Gary Anderson 8 months ago Contributor's comment

It could be added that the Fed seems to prune a rise in employment just before recessions. Some say pruning is not deliberate, but based on Kashkari and others' statements, I think the pruning is deliberate.