Italian growth: New recession or six-year decline?

Jeffrey Frankel

The Italian economy is reported to have slipped back into recession in the first part of 2014. This characterisation is based on a criterion for a recession standard in Europe – two successive quarters of negative growth. However, there are other criteria to define a recession. US standards would treat Italy’s economic situation as one, six-year-long recession. Whereas one cannot say whether one criterion is superior to the other, announcing a recession has further implications.

Italians and the world have now been told that their economy slipped back into recession in the first half of 2014. This characterisation is based on the criterion for recession that is standard in Europe and most countries – two successive quarters of negative growth. But this is not the only way to identify recessions.

If the criteria for determining recessions in Europe were similar to those used in the US, Italy’s new downturn would certainly be a continuation of its 2012 recession, not a new one.

US standards would treat Italy’s predicament as one horrific, six-year recession.

As Figure 1 shows, Italy’s been on a slippery slope ever since the shock of the 2008 Global Crisis.

The recovery in 2010-11 was so tepid that the level of Italian economic output had barely risen one-third the way off the floor, before a new downturn set in during 2012.

And the two earlier downturns were severe (Jones 2013); Italy’s GDP remains 9% below the level of 2008 (as Figure 1 shows).1

Figure 1. Real GDP in Italy, 2007 (Q1) – 2014 (Q2)

Why it matters

These issues sound like minor technical details. But they are not necessarily without real importance. Citizens in Italy have now been given the impression that they have entered a new recession.

Voters are likely to draw the conclusion that their new political leaders must have done something wrong.

But the picture is different if Italy has been in the same recession for six years.

The implication may be that the leaders have been doing the same wrong things throughout that period. It’s not an unimportant difference.

The loss in output since 2008 means that the debt/GDP ratio in Italy has risen during this period of fiscal austerity, not reversed as was supposed to happen under the plans to restore debt sustainability.

The same is true of other countries in the European periphery, making investor enthusiasm for their bonds over the last two years puzzling.

Recession criteria

What is the difference in criteria anyway? Economists in general define a recession as a period of declining economic activity.

European countries, like most, use a simple rule of thumb -- a recession is defined as two consecutive quarters of falling GDP.

In the US, the arbiter of when recessions begin and end is the Business Cycle Dating Committee of the NBER. The NBER Committee does not use that rule of thumb, nor any other quantifiable rule when it declares the peaks and troughs of the US economy. When it makes its judgments it looks beyond the most recently reported GDP numbers to include also employment and a variety of other indicators, in part because output measures are subject to errors and revisions.

The NBER Committee sees nothing special in the criterion of two consecutive quarters.

For example, it generally would say that a recession had taken place if the economy had fallen very sharply in two quarters, even if there had been one intermediate quarter of weak growth in between the other two quarters. Further, if a trough is subsequently followed by several quarters of positive growth, the NBER Committee does not necessarily announce that the recession has ended, until the economy has recovered sufficiently well that a hypothetical future downturn would count as a new recession instead of a continuation of the first one.

Fortunately, the US economy has had positive economic growth for the last five years, so these issues are not currently active on that side of the Atlantic. But things are not always so quiet. The US economy contracted three quarters in a row in 2001, for example, measured with the revised GDP statistics that are available today. But at the time when the NBER Committee declared that there had been a recession in 2001 (based on employment and various other indicators), the official GDP statistics did not show two consecutive quarters of declining output, let alone three (NBER Committee 2001). That episode is a good illustration of the benefits of a broader approach to the task of declaring business cycle turning points. The NBER Committee has never yet found it necessary to revise a date, let alone erase a recession, once declared.

Although the focus on a two-quarter rule and on currently-reported GDP statistics is common in the rest of the world, the NBER is not the only institution that looks beyond it. An analogous Euro Area Business Cycle Dating Committee was set up ten years ago by CEPR.

The CEPR Committee declared that the Great Recession ended in the Eurozone after the 2nd quarter of 2009, the same time as in the US (Uhlig 2010).

It also declared that a new second recession started in the latter part of 2011.

These were probably the right judgments. Growth in the quarters in between the two slump intervals was sufficiently strong in some countries, such as Germany, so that economic activity on average across the Eurozone had by mid-2011 re-attained about 2/3 of the ground that it had lost in 2008-09. Hence – two separate European recessions instead of one very long one. The Committee recently affirmed that it is not yet time to pronounce the second Eurozone recession over – in contrast to what the mechanical two-quarter criterion would suggest (CEPR Business Cycle Dating Committee 2014).

The CEPR committee passes judgment only on the Eurozone economy as a unit, not for individual countries within it, nor for countries like the UK that are outside the Eurozone. Individual countries remain entirely subject to statistical vagaries such as GDP revisions.

Should recession-dating criteria be mechanical?

One cannot say that the two-quarter rule of thumb used by individual countries in Europe and elsewhere is wrong.

There are unquestionably big advantages in having an automatic procedure that is simple and transparent, especially if the alternative is delegating the job to a committee of unelected unaccountable ivory-tower economists.

The press statements of the NBER Committee tend not to be greeted appreciatively. Each time, many critics express puzzlement at the need for a secretive committee, as compared to the alternative of an objective two-quarter rule. (Other critics each time complain that the committee has “only said what everybody has known for a long while”. Some critics have managed both complaints at the same time -- even when the two-quarter rule would not have given this answer that “everybody knows.”)

But there are also disadvantages to the rule of thumb.

One disadvantage to mechanical rules is the need to apply the white-out when the statistics are revised, as Britain had to do a year ago (Frankel 2013).

Britain announced a 2011-12 recession that was subsequently revised away. Claims that in 2012 had appeared in the speeches of UK politicians and in the writings of researchers, made in good faith at the time, were subsequently rendered false.

How to get Italy growing again

What are the right policies to get Italy and the others growing again? The same as for the last six years.

At the Frankfurt-Berlin-Brussels level, less austerity (Frankel 2014).

At the Rome-Lisbon-Athens level, reforms on the supply side, especially in labour markets (Boeri 2011).

It is true that supply-side reforms take time to have their full effect. But if authorities in Italy started handing out more taxi licenses to (qualified) drivers, employment would go up within a week.

References

Boeri, T (2011), “Institutional Reforms and Dualism in European Labor Markets”, in Ashenfelter O and D Card (eds.), Handbook of Labor Economics (Elsevier), pp.1173-1236.

CEPR Business Cycle Dating Committee (2014), “Eurozone mired in recession pause”, VoxEU.org, 17 June

Frankel, J (2013), “How many European recessions?” ProjectSyndicate.org, 17 July

Frankel, J (2014), “Considering QE, Mario? Buy US bonds, not Euro bonds”, VoxEU.org, 24 March.

Giannone, D (2012), “Real Time Uncertainty in Business Cycle Dating,” Universit´e Libre de Bruxelles, September 21.

Jones, G (2013), “Italy recessions becomes longest on record as GDP slumps”, Reuters, 15 May.

Kugler, A and G Pica (2006), “The eﬀects of employment protection and product market regulations on the Italian labour market,” in Messina J, C Michelacci, J Turunen and G Zoega (eds.) Labour Market Adjustments In Europe Ch.4, Edward Elgar.

NBER Business Cycle Dating Committee (2001), “The Business-Cycle Peak of 2001”, November 26.

Uhlig H (2010), “Euro Ares Business Cycle Dating Committee: Determination of the 2009 Q2 in economic activity”, VoxEU.org, 4 October.

Footnote

In general, the preceding peak is not always the right benchmark. On the one hand, that level of GDP may set too high a bar if it was above potential output, as in the particular case of the housing bubbles of the last decade. On the other hand, the preceding peak may be too low a benchmark because potential output has risen during the intervening months, especially in the case of developing countries with rapid trend growth in the labour force or productivity.