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« Weighing the Week Ahead: Are Earnings Expectations Too High? | Main | Weighing the Week Ahead: Time to Focus on Expectations? »

January 10, 2013

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Samuel Crowe

Thank you both for the model and explanation…very well done.

Would there now be a concern that the fed funds rate is so low that it plays no role in the model? And that a recession warning would likely initiate long before the fed funds would have a mathematical significance?

If inflation is an expansion of the money supply, and price inflation the symptom, would not the economy’s absorption rate (monetary expansion minus excess reserves) give heads up, since money supply contraction is often the coup-de-gras?

I would think, to get an honest state of the economy, the true rate of unemployment would be the number of unemployed looking for work plus the number employed by government or any job where any level of government funding is required to sustain that position. It appears that the proportion government jobs or government credited jobs have become a larger number in the employment statistics, where government employment really shouldn’t count at all.

Just some thoughts…but regardless I plan on keeping track of the model, and again thank you both for the work and the blog.

Samuel

Ken MacNeal

2008 was a watershed where old economics stopped working and "Balance Sheet" economics started. In a world that became overly indebted now we have deleveraging as a key driver. That is why even zero interest rates do not have people borrowing. The level of interest rates both long and short are totally manipulated and distorted. It used to be that the Fed would manipulate short rates but long rates were market driven. That is not the case any longer. Unfortunately this also makes models that depend on rates not work as they once did or at the very least one could say they are now suspect. I use the OECD CLI rather that the Conference Board CLI because it has less emphasis on interest rate fluctuations.

It would be great to see a chart of each side of the model separately to see how they forecasted separately.

Thanks for the thoughtful work.

wkevinw

Just a big thanks! Outstanding work, as usual.

Kevin

oldprof

Hi Bob,

I invited Bob Dieli to respond, and here is what he said:

"The model establishes no equivalence between the levels or rates of change of the variables. The model does note that when the variables are combined in the way described on the table the result informs us as the chances of us seeing a cycle event in the forecast period (the next nine months). Whether that is a peak or a trough depends on where we are in the cycle when the observation is noted.

The normal condition of the economy is for the inflation rate to be less than the unemployment rate. This is why the Real Spread is negative just about any time the economy is not in recession. The difference between the two series is telling us something about how well the real side of the economy is working. The "meaningful" part of the operation is the sign of the answer. The size does not really matter that much, as experience has shown that the economy is as prone to recession when the real spread is only slightly positive (as it has been around most cycle peaks) and when is extremely positive, as it was prior to the 1973 and 1981 recessions.

Please drop me a line directly, via the contact page on my web site www.nospinforecast.com and I will send you some additional charts."

Thanks for the interesting question.

Jeff

Bob

Great stuff as usual Prof. But there is one point that just is not clear yet especially to a layman such as myself. How does the model justify a treatment in which an increase of say 100 basis points in unemployment is precisely equivalent to a 100 BP decrease in inflation? Or to put it another way how can we subtract unemployment from inflation and have a meaningful number as a result? Is there a hidden rate factor X that just happens to have the value of 1 in units of (percent unemployment/percent inflation)?

oldprof

RB -- Good eye! The government did not have the "long bond" during one stretch, so the long yield was sometimes the 20-year and sometimes the 30-year. It is not significant for the results.

Jeff

RB

Jeff- another question. Did Bob Dieli always use the 20 year bond for this spread measure? I don't see monthly data for the late 80s/early 90s period.

RB

Very nice job. What is striking is that this is not a mechanical model, but one that involves judgement. The other indicator that you discuss in your weekly reports, the Superindex, strikes me as having a more mechanical approach, combining various recession indicators. the superindex also had smoother transitions for the 2008/2009 recession. It also seems to involve some fitting for determining trigger thresholds based on past recessions. I wonder if you have any thoughts on comparing the two approaches.

Mr. AggregateSpread makes me feel better though about sitting out of the market from mid-2006 until 2009. It wasn't easy watching the market go up in 2007.

Joe

Jeff: thanks for your very helpful blog, a real eye-opener and refreshingly absent of ideology.
My comment for this recession-forecasting model post is that it seems to be helpful for the timing, but not for the severity of a recession. The recession(s) 1980-82 appears much much worse than the recent Great Recession, which appears to be just as light if a bit longer than the 1990 and 2001 recession. But in reality it was the worst of them all.

Proteus

Great post, Jeff. Very well written and clearly a lot of thought and effort was put into this.

And congratulations, you're hit the big time - this story is on the home page of Business Insider.

SI

Good segments, but would have preferred a consolidated 20 min discussion, notwithstanding the universal tendency to pander to short attention spans.

wei

A much simpler indicator is to just use the yield curve. If it is inverted, then a recession is coming. If it's steep, then a recession is far away. It's MORE accurate and MORE simple. and you don't need to pick an arbitrary level of 200bps to indicate recessions, which in my opinion is just massaging the data to fit the conclusion you're looking for.

But then again, we're a victim of selection and survivership bias. we're just selecting the data series that proves out a given pattern. Using this methodology, you can find "forecasting" tools for almost any pattern. That is why forward looking analysis is important. For example, the Fed can keep us in expansion phase by just keeping the short rate at zero forever! but we all know that this doesn't work for a lot of reasons.

The fed has gotten very aggressive at keeping the yield curve steep, so i suspect that the "inverted yield curve" indicator alone is going to be a poor recession indicator. You can already see this in the last two recessions, where the contribution from the yield curve component of the Aggregate Index is less pronounced.

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