David Leonhardt and Recession Odds

David Leonhardt comes to the study of business and economics (and sports) with his background in mathematics.  This gives him special insight into some quantitative topics.  His work gets a great platform — The New York Times.

Yesterday, in his regular Wednesday column, he wrote that we are at a "fork in the road" and that he put the odds of a recession next year at 50-50.

He does a very nice job of summarizing a number of recession indicators.  The article is worth reading just for that.

I wonder how many of his readers noticed that the conclusion he reaches is in no way supported by the evidence he cites!  He says that the Economic Cycle Research Institute has done a great job of forecasting recessions without the false signals.  So what does the ECRI say?

Perhaps most telling, the people at the Economic Cycle Research
Institute are getting nervous. “We’re not calling for a recession yet,”
Lakshman Achuthan, the institute’s managing director, told me. “But the
risks to the economy have materially increased.”

That seems pretty clear.  They are watching a slowing in the rate of economic growth, but not yet predicting a recession.  The ECRI work gets a lot of well-deserved publicity, and this is part of the reason — avoiding false signals.

Leonhardt cites a second leading indicator of his own creation, giving himself a little pat on the back since it was mentioned in Fed Research on Forecasting.  His Anxious Index is not yet signalling a recession by his own criterion–30% forecasting a slowdown–and it is not close.  Nevertheless Leonhardt offers this assessment of the odds:

In the most recent survey, released Aug. 14, the economists put only a
10 percent chance on a downturn in the fourth quarter of this year.
Further out, however, they were less confident. They said there was a
16 percent risk that the economy would shrink two quarters from now.
About 40 percent of the time they have gotten this anxious in the past,
a recession has started at some point during the following year.

Alarm bells should be going off for the careful reader.  How many recessions and predictions have there been since 1968?

That would be five — count ’em — five.

There is not enough experience with this (two-quarter) indicator to draw any conclusions with confidence, but an unbiased observer might note that it has usually been wrong.

David Leonhardt wants to be among the first to warn you about the coming recession. He strays from the quant stuff into some personal opinions
about the Fed and Wall Street Economists, opinions which are factually
incorrect. [Another post on this later,
since it is a different theme.]

Read the article, but ignore the implied investment advice.  Also, he mentions the significance of tomorrow’s payroll number.  Before reading too much into that, you should play the Payroll Employment Game.

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