The Unassuming Economist

An interesting presentation on recession dynamics by Tara M Sinclair from George Washington University. They answer three fundamental questions:

“1. Are we in a recession now?

2. When is the next recession coming?

3. What will the next recession look like? ”

Source: Recession 2020? Tara M. Sinclair @TaraSinc The George Washington UniversityResearch  Program on Forecasting

An intriguing analysis by the SEI Knowledge Center on forecasting recessions:

“To explore this possibility, we looked at the last 13 recessions in the US dating back to 1937. US data was used due to availability of a longer history; we believe the core conclusions of the analysis should be the same for any geography or market. We considered a range of sell-and-buy scenarios surrounding the official start and end dates of each recession, as determined by the National Bureau of Economic Research (or NBER, a private, non-profit, non-partisan organisation). The timing of our hypothetical decisions to sell out of the market and buy back into the market varied by up to eight quarters before and after each actual recession start and end date. This gave us a grand total of 2,577 scenarios to consider, as highlighted in Exhibit 1.”

Exhibit 1: Endless Possibilities

Source: Bloomberg, SEI

From Bloomberg:

“Economists, notoriously terrible at predicting downturns, may be inadvertently providing a useful service.

It’s no secret that economists are terrible at predicting recessions: a host of studies, along with a raft of anecdotal evidence, reveals a track record that is astonishingly bad. This has prompted a growing number of market watchers to conclude that forecasting recessions is a fool’s game.

But there’s another way to look at this dismal record. What if economists are so bad at predicting recessions that they’re actually good? What if a profession that consistently, almost universally, gets something wrong is inadvertently getting something right?

Prakash Loungani and his colleagues at the International Monetary Fund conducted the most sophisticated studies of economic forecasting, assessing the accuracy of economists in 63 countries between the years of 1992 and 2014. The results, as my colleagues at Bloomberg have noted (see here and here) are mind-blowingly awful. In fact, every single country displayed the exact same bad track record of predicting recessions. Moreover, as Loungani and his co-authors noted, “the forecasts of the private sector and public sector are virtually identical; thus, both are equally good at missing recessions.”

Good at missing recessions. Think about that for a moment. Economic forecasts consistently miss the onset of recessions.

This means that their failure to predict is a problem altogether different from the failures emphasized by the random-walk hypothesis and other critiques of prognostication. Economists predict the future incorrectly, but their failures are, well, predictable. Does that mean they may be telling us something important after all?

To understand the implications of this question, consider the typical progression of erroneous forecasts over the course of a recession’s first year. Loungani found that forecasts made on the eve of a recession (when almost no one imagines there’s trouble brewing) are more or less in line with the previous year’s predictions.”

Continue reading here.

From a VOX article:

“Business economists argue that the length of an expansion is a good indicator of when a recession will hit. Using both parametric and non-parametric measures, this column finds strong support for the theory from post-WWII data on the US economy. The findings suggest there is good reason to expect a US recession in the next two years.”

“[…] we estimate in Beaudry and Portier (2019) the probability of the US economy entering a recession in the following year (or following two years), conditional on the expansion having lasted q quarters. This can be done in a parametric way based on the Weibull distribution, or non-parametrically using Kaplan and Meier’s estimator of the survival function. Regardless of the method, and using post-WW2 US data, there is consistent evidence of age-dependence, as shown in Figure 1. For an expansion that has lasted only five quarters, the probability of entering a recession in the next year is around 10%, while this increases to 30-40% if the expansion has lasted over 35 quarters. Similarly, if looking at a two years window, we find the probability of entering a recession in the next two years raises from 25-30% to around 50-80% as the expansion extends from five quarters to 32 quarters (the exact probability depends on whether we use a parametric or a non-parametric approach). ”

From a VoxEU post by Franck Portier:

“Business economists argue that the length of an expansion is a good indicator of when a recession will hit. Using both parametric and non-parametric measures, this column finds strong support for the theory from post-WWII data on the US economy. The findings suggest there is good reason to expect a US recession in the next two years.

This summer, the current US expansion, which started in June 2009, is likely to break the historical post-WWII record of 120 months long, which is currently held by the March 1991-March 2001 expansion. It is already longer than the post-WWII average of 58 months. Should we be worried? Is the next recession around the corner?

Yes, according to business economists. For example, according to the semi-annual National Association for Business Economics survey released last February, three-quarters of the panellists expect an economic recession by the end of 2021. While only 10% of panellists expect a recession in 2019, 42% say a recession will happen in 2020, and 25% expect one in 2021.

No, according to the conventional wisdom among more academic-oriented economists, who believe that “expansions, like Peter Pan, endure but never seem to grow old”, as Rudebusch (2016) recently argued. As he wrote, “based only on age, an 80-month-old expansion has effectively the same chance of ending as a 40-month-old expansion”. This view was also forcefully expressed last December by the (now ex-) Federal Reserve Board Chair Janet Yellen, who said “… I think it’s a myth that expansions die of old age. I do not think they die of old age. So the fact that this has been quite a long expansion doesn’t lead me to believe that … its days are numbered”.

My research with Paul Beaudry and Dana Galizia tends to favour the former view, that we should be worried about a recession hitting the US economy in the next 18 months.

There are two reasons why we reach this conclusion. The first relies on a statistical analysis that uses only the age of an expansion to predict the probability of a recession. The second digs deeper into the very functioning of market economies.

First, we estimate in Beaudry and Portier (2019) the probability of the US economy entering a recession in the following year (or following two years), conditional on the expansion having lasted q quarters. This can be done in a parametric way based on the Weibull distribution, or non-parametrically using Kaplan and Meier’s estimator of the survival function. Regardless of the method, and using post-WW2 US data, there is consistent evidence of age-dependence, as shown in Figure 1. For an expansion that has lasted only five quarters, the probability of entering a recession in the next year is around 10%, while this increases to 30-40% if the expansion has lasted over 35 quarters. Similarly, if looking at a two years window, we find the probability of entering a recession in the next two years raises from 25-30% to around 50-80% as the expansion extends from five quarters to 32 quarters (the exact probability depends on whether we use a parametric or a non-parametric approach).”

Continue reading here.