From December 2007 to the end of the second quarter of 2009, the United States suffered its most severe economic downturn since the Great Depression. This period is now referred to as the “Great Recession.” While much of the rest of the country appears to be emerging from this long downturn, it is less clear that the recession has run its course in California or the Inland Empire.
Despite current economic news claiming that job creation in the United States reached a three year high in March 2010, unemployment rates in California rose to an astonishing 12.5 percent in February 2010—the highest unemployment rate since the state began publishing this data in 1976. Only three other states—Michigan, Nevada, and Rhode Island—have a weaker labor market than California. Worse yet, unemployment rates in the Inland Empire increased from 14.1 percent in December 2009 to 15.0 percent in January 2010, a very large jump in a single month. According to the seasonally unadjusted February data, San Bernardino and Riverside Counties are currently facing unemployment rates of 14.4 percent and 14.9 percent respectively, which are approximately 10 percentage points higher than what they were in May 2007.
Unemployment is one measure of the health of an economy, but it can be a misleading—or at least insufficient—measure because it is frequently a lagging economic indicator. For example, the national unemployment rate reached a peak of 10.1 percent in November 2009, even though the recession supposedly ended several months earlier.
What measures should business leaders in the Inland Empire use when considering whether to hire new full time workers and make long-term investments?
Business Cycle Indicators
To forecast economic activity in the Inland Empire, we have created two new economic indices specifically for the region—a “Coincident Economic Index” (CEI) to gain information about the current state of the economy and a “Leading Economic Index” (LEI), which tries to predict the future state of the region’s economy.
CEIs and LEIs for the United States were originally introduced in the 1930s by the National Bureau of Economic Research (NBER), a non-profit economic think tank. The national CEI currently contains four economic series (non-farm employment, industrial production, manufacturing and trade sales, personal income less transfer payments), while the national LEI has ten series pertaining to stock price, real estate, and other measures of production.
In the graph below, shaded areas correspond to U.S. recessions, as dated by the NBER. Contrary to popular perception, the NBER does not define “recession” as two consecutive quarters of negative growth. Instead, the NBER defines a recession as a period of diminished economic activity. The NBER designated the onset of the Great Recession in December 2007, but has not determined its end date. Indeed, on April 12, the NBER announced that its Dating Committee has decided it is premature to date the recession’s conclusion. Other organizations, such as the Federal Reserve Bank of St. Louis, estimate that the Great Recession ended in July 2009, while the Lowe Institute Business Cycle Dating Committee favors June 2009 as the end date.
Column 1 of Table 1 (on the following page) lists the beginning and end of the seven most recent U.S. recessions as dated by the NBER. The interested reader can find U.S. recessions and expansions dating back to 1854 at the NBER website.
Ideally, the LEI should forecast economic conditions at least three months into the future to help businesses and the government make budget and inventory decisions. In a few instances (as in 2001) the LEI provided less than a three month warning about an approaching recession.
Other times (as in 1995) the LEI indicated that, despite signs of a downturn, a recession never occurred. The LEI is less successful in forecasting recoveries than the onset of recessions. Sometimes (as in 1975, 1980, and 1991) the LEI indicated a recovery only two months before the end of a recession. While these indices may not be perfect, they do a reasonably good job analyzing current and future economic business conditions, which explains their popularity with the business community.
California
While the NBER is widely recognized as the unofficial arbiter of dating business cycles in the United States, there is no reason to believe that business cycles are identical for all regions across the country.
Dating recessions for smaller geographic areas is controversial. For example, Ed Leamer of UCLA Anderson Forecast has argued that a recession resembles a national disease, where infections do not occur at the same time in all parts. One can think of the flu season as an analogy. This argument might suggest that we should only choose national dates for the recession.
We believe, however, that when a geographical area, such as California, is large enough and a recession shows distinct regional variations, separate dating is justified. California differs from other geographic areas in the United States in both population size and in State Gross Domestic Product. With approximately 38 million residents, California is more populated than Canada and approximately the same size as Australia or the Netherlands. The bottom line is that, by virtue of its population size and total output, California deserves individual consideration.
Moreover, the flu analogy may not hold if the flu does not affect the country as a whole. It is well known that the 1990s recession in the United States was primarily bi-coastal in severity and had a much greater impact on California than it did on a state like Texas, which did not experience a downturn. Despite variations of this type, economic indices by state are scarce and have not been thoroughly analyzed. The Federal Reserve Banks of Dallas, Minneapolis, and New York date recessions for states in their district while the Federal Reserve Bank of Philadelphia has created CEIs for each state. The Federal Reserve Bank of San Francisco has been lagging in this respect, however, which seems remarkable given the sheer size of the California economy. California’s importance is evidenced by the fact that if the state were removed from the picture, the U.S. economy would have had no negative annual growth during the recessions of 1990-1991 and 2001.
Many economic series for California date back only to 1979. As a result, the Lowe Institute Business Cycle Dating Committee has analyzed California’s business cycles over the past three decades—a period that includes four national recessions. This analysis indicates that:
• The timing of the 1981-1982 recession was approximately the same in California and the nation. This downturn began when the Federal Reserve introduced a new tight monetary policy.
• The 1990s recession began simultaneously in California and the rest of the United States. However, this recession’s effects were more severe and prolonged in the Golden State. The recession lasted 41 months in California, finally ending in October 1993. By comparison, the Great Depression of the 1930s lasted 43 months. While California suffered an additional decline in economic activity in early 1994 due to the Northridge earthquake, the Dating Committee did not believe this event warranted the extension of the recession into 1994, but rather viewed it as a one-time shock.
• The 2001 recession in California largely coincided with the national recession, but lasted longer, which can be explained by the acute damage Northern California experienced from the burst of the dot com bubble.
• The current recession had its origins in California, particularly in the real estate sector and the sub-prime mortgage crisis. The recession also gained additional momentum with the steep rise in oil prices in the state. Gas prices in San Francisco reached $3.60 in the summer of 2007 and were almost that high again in November of that year. Some remote areas of the state reported prices of over $4.50 during that same time period. The Dating Committee evaluated significant decreases in economic activity in all of California starting in the summer of 2007, almost half a year before the official start of the U.S. recession. While some have argued that the recession ended in California by early 2010, we disagree.
The Federal Reserve Bank of Philadelphia has produced a CEI for all U.S. states, including California. Although the methodology used to generate the CEI is different from that employed by the Conference Board and by the Lowe Institute Business Cycle Dating Committee, there is much agreement between the CEI and dates we have chosen.
In general, the CEI of the Philadelphia Fed identifies recessions that are slightly shorter than the ones identified by the Dating Committee.
Inland Empire
The Inland Empire is the second largest Metropolitan Statistical Area in California and has a larger population than either the Greater San Francisco or San Diego areas. By constructing a CEI and an LEI for the Inland Empire, we hope to provide business leaders and government officials a better understanding of economic activity in this region. We have identified historic economic peaks and troughs in the Inland Empire by looking at a variety of economic series. Because adequate data on a county level did not become available until approximately 20 years ago, our analysis is limited to the three most recent U.S. recessions. Table 1 provides the dates of the recessions for the Inland Empire since 1990. As this table indicates, the Inland Empire has behaved quite differently in recent recessions than the rest of California and the United States.
• The 1990s recession in the Inland Empire was quite severe. The downturn started approximately half a year later than in the rest of California and ended approximately half a year earlier.
• Although the Inland Empire experienced a rising unemployment rate during 2001, the Lowe Institute Business Cycle Dating Committee decided that the region did not experience a recession in the early 2000s. This is because employment never decreased during this period. The increase in the region’s unemployment rate in the early 2000s can be attributed to the rapid growth of population in San Bernardino and Riverside Counties.
• The Great Recession has been more severe in the Inland Empire than in other parts of the country because the region has been harder hit by the subprime mortgage crisis and its aftermath. The current recession started in the Inland Empire in March 2007 and still has not reached a conclusion.
The Lowe Institute’s Coincident Economic Indicator for the Inland Empire is composed of the following three series: employment, unemployment rates, and average hours of manufacturing.
The Inland Empire CEI decreases during recessions. This index suggests that the Inland Empire’s decline in economic activity may be slowing, although it is too early to predict recovery.
While the CEI is useful, most decision-makers want to know about the immediate future for planning purposes. Accordingly, the Lowe Institute combined the LEI for the United States with housing starts in the Inland Empire and the change in housing starts. The index takes into account the fact that economic activity in San Bernardino and Riverside Counties heavily depends on trends in the rest of the country, as well as in the local housing and construction industries.
The Inland Empire index turns significantly downward before the recession of the early 1990s and current recession began, and shows a steady increase before the Inland Empire exited the recession in the early 1990s. Furthermore, the index does not predict the recession of 2001, which, in fact, largely bypassed the region. The Inland Empire escaped that recession largely because the regional housing boom mitigated the impact of the dot com bust. Notably, the Inland Empire LEI shows an upturn at the end of 2009 or beginning of 2010—which provides some hope that the region should soon see an economic recovery. However, this finding should be viewed with caution, because the limited availability of historical economic data for the region makes it difficult to verify the model’s reliability until after the recovery is well underway.
