August 20, 2019, 00:29 / Opinions

How to predict a recession

The best available indicators are not necessarily good - but an unfulfilled prophecy can be useful

Ruben Enikolopov , Rector of the Russian School of Economics The very fact of predicting a recession can change the behavior of economic agents and lead to the fact that the forecast does not come true

Recently, numerous signs of an impending global recession have become increasingly discussed. Everyone understands perfectly well that the ongoing trade war between the United States and China cannot but have a negative impact on economic growth. But there remains enormous uncertainty about how far each side is willing to go in this conflict, how deep the trade war's impact on economic growth will be, and whether it will be enough to push the global economy into recession. That is why investors and experts are extremely closely, if not frantically, monitoring any possible indicators that may help predict an impending recession.

Over the past week, there has been a lot of active discussion about the fact that the US government bond yield curve has taken the form of an inversion. This means that interest rates on short-term three-month bonds were higher than on long-term 10-year bonds. This fact was discussed so actively that even people who first heard the word “inversion” and were forced to look for its definition in Wikipedia began to actively discuss this sign of the coming recession.

An inversion of the yield curve is indeed quite an unusual condition, since long-term debt is normally associated with greater risks, which translates into higher rates. The fact that long-term rates are falling below short-term rates, even despite the difference in risk, means that investors expect that short-term rates will also fall in the future. This could happen both because central banks will reduce them and because there will not be enough demand for investment. Both happen during recessions, so ultimately an inversion of the yield curve actually turns out to be one of the most reliable indicators of its approach. This is what the Federal Reserve Bank of New York uses to predict the likelihood of a recession.

Investors are tired of uncertainty

Economics / World Economy

Unfortunately, just because this indicator is the best available does not make it really good. The sad fact is that economic experts' track record when it comes to predicting recessions is disastrous. Back in 1966, Nobel laureate economist Paul Samuelson wryly noted that the decline of the American stock market had successfully predicted nine of the last five recessions. Unfortunately, since then there has been little progress in finding indicators that would reliably predict an economic slowdown. A recent review of IMF researchers who raised economic forecasts for 63 countries from 1992 to 2014 found that of 153 recessions, forecasters were able to predict their occurrence a year in advance in only five cases. Considering that, on average, countries spend about 10% of their time in recession, one could do much better by simply predicting that there will be a recession every time next year (which is, in fact, what some well-known experts, such as Nouriel Roubini).

As Niels Bohr said, it is very difficult to predict, especially to predict the future. But in economics this is even more difficult, since the very fact of predicting the same recession can change the behavior of economic agents and lead to the fact that the forecast will not come true. For example, in the current situation, active discussion of a possible recession could change the policies of US President Donald Trump. He is well aware that the onset of a recession will ruin his chances of re-election in 2020, and therefore is doing everything possible to avoid such a development. This explains Trump's unprecedented (and quite successful) pressure on Fed Chairman Jerome Powell to cut interest rates. Almost immediately after the news of the yield curve inversion appeared, White House economic adviser Larry Kudlow said that the presidential administration was seriously studying the possibility of another tax cut. This may well be enough to, if not prevent a recession, then at least delay it.

So it is quite possible that we will witness another “self-fulfilling” prophecy, when the very fact of predicting a crisis leads to its not happening. But if in medicine such predictions that did not come true due to preventive measures are interpreted as a medical success, in economics this makes it possible to once again scold experts for their inability to predict crises. And God grant that this happens more often.

The author is the rector of the Russian Economic School

Eight unusual economic indicators

1 / 16

A decrease in the number of pregnancies is a sure sign of an approaching recession in the economy, <a href="https://www.vedomosti.ru/economics/articles/2018/02/26/752067-ispolzovat-rozhdaemost">revealed by the US National Bureau of Economic Research ( NBER)</a>. The number of conceptions began to decline at least six months before the start of the last three recessions in the United States - in the early 1990s and early 2000s. and the end of the 2000s.

/ Polina Korchagina / Interpress / TASS