Summary: How close is the US economy to a recession? Here we review the evidence and draw a firm conclusion. {1st of 2 posts today.}
The financial press overflows with confident forecasts about everything from individual stock prices to the fate of the overall economy. It’s usually difficult to reliably predict such things with useful accuracy; since the crash it’s become far more so. My prediction each year since 2010 has been for slow growth (in the low 2%’s); that’s proven correct. Let’s try for something more ambitious.
Contents
- How close are we to a recession?
- The Econbrowser Recession Indicator Index.
- Looking at Q1 GDP.
- How fast can GDP fall?
- The current numbers: how are we doing?
- Conclusions
- For More Information
(1) How close are we to a recession?
Let’s start with the big picture and move to the details. GDP was moderately strong in Q3 and Q4 at aprox 2.6%. Economists expect a strong economy (as usual). Looks good.
But some (not all) indicators show slowing. That’s sparked excitement from the bears, like this from Zero Hedge: Two More Harbingers Of Financial Doom That Mirror The Crisis Of 2008.
But before examining the data, we need some context. Surveys of consensus opinion of economists have never predicted a recession (correctly or incorrectly). So their sunny forecasts tell us little.
Second, the economy has experienced unprecedented distortion from six years of fiscal and monetary stimulus — including maintaining the short-term risk-less interest rate at zero, long-term government bond yields below the inflation rate (aka negative real rates), plus three rounds of quantitative easing. These have made many of the usual forecasting tools less effective.
(2) The Econbrowser Recession Indicator Index.
For useful perspective see a tool developed by James Hamilton, Professor of Economics at UC-San Diego. His Econbrowser Recession Indicator Index is an indicator of contemporaneous data — its quarterly indexes are not changed as data is revised. See his article describing it. It now reads 1.6% — low odds of a recession, slowly falling.
(3) Looking at Q1 GDP.
Real GDP was aprox 5% SAAR in Q2 and Q3 of 2014, slowing to 2.6% in Q4. The Atlanta Fed gives a “NowCast” for current quart GDP, showing the estimates of their model and the Blue Chip Forecast. As of Feb 12: 2.2% (2.7% by the Blue Chips) for Q1. Not great, but typical since the crash. Note the wide and widening range of economists’ forecasts; estimates usually narrow during the quarter.
(4) How fast can GDP fall?
Could we have a recession in 2015? We could easily fall into a recession if there was a sufficiently large shock to the system. Rapid drops into recession are common from our current growth rates.
There have been 260 quarters since 1950. There were 29 quarters (11%) with falls of over 500 bps (i.e., 5 percentage points) in a single quarter (i.e, the difference between QoQ SAAR GDP changes), with 4 quarters having falls of over 1,000 bps. The worst quarter of the recent crash was -630 bps in Q4 2008. A commonplace shock could kick us into a Q2 recession; there’s a long list of candidates.
Real GDP increased 2.4% in 2014. In the 260 quarters since 1950 there were 12 quarters (5%) that had trailing 4 quarter drops of 250 bps or more. The worst 4 quarters of the crash ended in Q4 2008 with a 2.5% drop. So a long recession starting in 2015 is quite possible.
(5) The current numbers: how are we doing?
The data is often confusing. At inflection points in the business cycle the data are even more so than usual, which is why accurate forecasting is difficult. People tend to create strong-sounding forecasts by selective citation of indicators. That’s easy these days, since the data is so noisy.
New Claims for Unemployment, a strong leading indicator, are flat. Manufacturers’ New Orders, another leading indicator, have fallen for the past 3 months.
Weak Retail Sales has generate much clickbait, having fallen for the past 2 months — but it’s a a coincident indicator.
The jobs numbers for January excited the bulls, but that’s a lagging indicator. The jump in the Total Business Inventories/Sales Ratio excited the bears, rising to the highest since July 2003 (excluding the recession) — but that’s also a lagging indicator.
(6) Conclusions.
The US economy is of almost unimaginable complexity, rapidly changing and linked to an even larger and more complex world economy. So accurate forecasting has always been difficult. But in 2008 the economy — both domestic and global — began a process of rapid change — met by extraordinary responses by governments. We’ve seen the effects in Europe and Japan. China has successfully coped, but many experts question for how long this can continue.
Forecasting relies on models built on historical data and past relationships among economic variables. When those relationships change, then the models no longer work.
Forecasters sell what we want, which is confident guesses about the future. In times like now we value reassurance more than usual, and they provide it.
Manipulating public opinion is a powerful tool of government, especially as a means to maintain confidence — so that Keynes’ animal spirits boost spending and investment. Central banks have done this brilliantly since the crash, boasting of their influence over a range range of factors — from interest rates to asset prices. We love it, especially the libertarians of the investment industry.
What comes next? How long will this cycle continue? What comes next? I don’t know. The data is confusing, as it has been since 2010 (after the bounce-back from the recession).
I doubt that anyone can predict with any accuracy. All we know is that the economy remains stuck in slow, and hence vulnerable to a recession. Many people — including me — fear that the next recession might be unusually bad. There is as yet insufficient evidence to declare that one approaches.
Stay tuned for more updates.
(7) For More Information
(a) The big question: Are we following Japan into an era of slow growth, even stagnation?, 18 November 2013
(b) Posts about “stall speed”:
- The dilemma of the US economy: can’t take off & too close to the brink, 9 July 2014
- Has America’s economy entered the “coffin corner”?, 10 July 2014
(c) Posts about forecasts:
- Did anyone predict the 2008 crash? Will anyone predict the next crash?
- Lessons from WWI about “markets” ability to see the future (spoiler: they don’t do it well)
(d) Posts about our current economy:
- Dreams of a boom fade & attention turns to secular stagnation., 4 February 2015.
- Listen to the slowing US economy, hear echoes of Japan, 6 February 2015.
What is the source of business-cycle fluctuations? Overproduction? Underconsumption? Investment distortions caused by interest rates below the ‘natural rate’? Are their multiple causes that appear at various times,e.g. exogenous shocks, inventory build up, financial panic? Or simply the preference for liquidity, in reaction to some event(s) not previously anticipated ? Does the hypertrophy of finance in the last 30 years change the picture?
If we don’t know where they come from, do we wind up with a sort of technical analysis that seeks patterns where none may exist, at least in the sense of patterns as manifestations of actual processes?
I think the discussion benefits if the author shares his analytical framework
Wabon2,
All good questions. There is, of course, no one cause of recessions. Downturns are a result with many causes. It’s like asking “what is the cause of sickness?” Toxins (internal or external exposures), pathogens, psychological, dietary, physical injuries, iatrogenic, hereditary, etc.
IMO given the capitalistic nature of our economy, and by definition its dependence on consumer spending, cyclical crisis occur when workers lack the necessary disposable income to purchase goods and services that allow business and new business to grow with corresponding hiring and wage increases. Take away the disposable income that results from employment and not surprisingly the result is slow growth, w/no uptick in sight until well paying jobs are created from the development of 21st century industries.
Numbers in spreadsheets can be manipulated to represent a phantom economy but that will not change the reality of our consumer driven, capitalistic economy. All the rest is just explanation and noise that detracts from solving our fundamental problem … good paying jobs.
I understand that Mr. Market prefers to pay as little as possible … for everything, especially labor; we’ve followed Mr. Market and even novels written by crackpots only to find ourselves in a slow growth morass that has resulted from Mr. Markets financial recession. Mr. Market needs to revise his thinking around the fundamental concepts that make a consumer driven economy successful. They used to teach that in schools of marketing and business.
Desenter,
“cyclical crisis occur when workers”
There is no one cause of recessions, let alone economic crisis. These things are far too complex for such simplifications.
One of the most common causes of a crisis is a collapse in the banking system. In fact, almost all large economic crisis have a banking collapse at the start or early stage. Although such events have in turn their own causes. But inadequate consumer spending is seldom one of them.
Reader question: “Why is slow growth a bad thing?”
Slow growth is better than no growth! Also, the reality of slow growth contracts the often-heard but baseless claim that we’re still in a recession (that was nuts in 2010, and more so 5 years later).
The problem with slow growth: it makes us vulnerable to shocks. To use a bad analogy, we are like an airplane flying close to stall speed. If fact, there is a theory saying that economies do have a stall speed of aprox 1% gdp/ year. (See the For More Information section in the post to learn about this.)
Even a moderate shock and — bang, we are in recession. That would be especially unfortunately since we have already used some of our counter cyclical stabilizers. Rates are at zero, the deficit is already at a moderate level.
Honestly the prospect of another big recession now is quite frightening. For the USA and the stronger western states like Germany it might still be survivable albeit with a lot of scars. In places like Greece or Italy it would likely be the final straw, with people fighting each other over trash bin content and Golden Dawn style jackbooted thugs or others nutters in charge. The EU would probably cease to exist.
Marcello,
“Honestly the prospect of another big recession now is quite frightening.”
Oh, yes — it would be hard for the US (most of us, anyway). On the other hand, how much would it affect Spain or Greece? A recession is largely a downturn in the cyclical sectors. In those nations the cyclical sectors are already bust.
FM: “On the other hand, how much would it affect Spain or Greece?”
I understand where you are coming from, FM, but one of the corollaries of Murphy’s Law is “no matter how bad the current situation is, it can always get worse.”
Pluto,
Perhaps so, but I don’t believe that provides a useful guide for economic forecasting.
In fact, the opposite is almost always true. Economic conditions usually return “to the mean” — that is, they return to the long-term trend. The people doing that kind of straight line extrapolation — assuming bad conditions will get worse — are almost always wrong.
Agreed, FM. I offered my comment mostly in jest.
There is an interesting point in your reply that deserves further thought. Do “economic conditions usually return to the mean” after extreme economic conditions such as depressions or losing a war (or winning a narrow victory)? Doesn’t the mean also have to move to adjust to the very large changes that occurred during the catastrophe?
Greece, regardless of how the current crisis finally ends, will not be the same place it was before the Euro zone started pumping so many billions of Euros into it (that includes before 2008).
Pluto,
That’s a great point, on something commonly misinterpreted. What returns to the mean are trends, not levels. Normal recessions since WWII are wiggles on the upward lines (e.g., GDP). But severe downturns, like the Great Recession, are resets. The growth line resumes, perhaps even at the same slope (eventually, if growth “takes off”), but on a lower level.
The damage to Europe’s periphery is far more severe. Return to conditions ante crash will take years or perhaps decades. And that assumes they fix the growth engines.
The original point was that extrapolating downturns to zero is fallacious. Even in depressions an economy drops down only to a lower level of stability. It’s an important point. Only non-economic events (e.g., wars, natural disasters) reduce people to ruins. Economic downturns don’t destroy anything. That’s Keynes’ big insight. Even in the worst depression nothing has happened to society’s ability to generate income. The engine is jammed, not broken. Its people and resources are there, just as they were before the crash.
“Even in the worst depression nothing has happened to society’s ability to generate income. The engine is jammed, not broken. Its people and resources are there, just as they were before the crash.”
I have difficulty to believe that this is generally true, and that it does not crucially depend on the length of the depression. For instance, long-term unemployed tend to lose their skills, which definitely affects the “society’s ability to generate income” especially in a context of demographic contraction. Technically, there is also industrial equipment that must be put to use regularly (e.g. ships) or maintained (e.g. buildings) otherwise it deteriorates.
guest,
Yes to both. But you’re missing the point. Those are trivial drops compared to a society’s overall stock of natural resources, infrastructure and other physical plant, and human skill. The big picture is that an economic decline is a social event, fixable by social actions. No matter how big the crash — nothing has happened. The society has disorganized itself, but is essentially as rich as before the crash. In that sense a crash-depression-whatever takes place in our minds, not the real world.
“On the other hand, how much would it affect Spain or Greece?”
A lot of things are running on the fumes of the promise of an incoming recovery. If the world economy goes under again it might get ugly, even if economic losses were less than the USA percentage wise.
Marcello,
You might be right, but such predictions are notoriously unreliable. In particular I question the “running on fumes” analogy. What exactly does that mean in this context?