Is another U.S. recession a ‘done deal’?


Today we’re pleased to feature a guest contribution from Michael Dueker, chief economist at Russell Investments and formerly an assistant vice president in the Research Department at the Federal Reserve Bank of St. Louis. Dueker is also a member of the Blue Chip forecasting panel. Econbrowser readers may remember that in February 2008 Dueker correctly predicted the onset of the current recession, using a model-based forecast. In a depths-of-recession piece from December 2008, he predicted in this forum that the recession would last until July or August of 2009, but that employment growth would not resume until March of 2010. We asked Mike to share the latest macroeconomic predictions from the Dueker Business Cycle Index model, subject to the disclaimer that the content does not constitute investment advice or projections of the stock market or any specific investment.

Is a U.S. recession a ‘done deal’ or would future shocks, such as European conflagration, be necessary to tip the U.S. toward recession?

Michael Dueker

Recession probabilities once again are Topic One in the United States. This week the influential Economic Cycle Research Institute (ECRI) took the position that a U.S. recession is inevitable in the near term if it has not started already. Regarding Europe, many observers believe that a Eurozone recession is in the works, but the likelihood that the United States will follow suit is a subject of intense debate. To add a dissenting voice to ECRI’s claims about the inevitability of a U.S. recession, I highlight here forecasts from my Qual VAR model (or this link) that are posted monthly on

Before even looking at model output, I start with the observation that the measures of financial market concern about the state of the economy that go into the Qual VAR model are not showing acute stress at present, especially relative to their values in late 2007 and and early 2008. For example, the TED spread between 3-month LIBOR and the 3-month T-bill rate has to consider that, since December 2008, the LIBOR yield has had a floor under it equal to the 25 basis point interest rate the Fed has been paying on excess reserves. Viewed this way, the current 3-month LIBOR yield of about 32 basis points in September 2011 does not represent much stress in interbank lending markets at all. Similarly, the Baa-Aaa corporate bond spread averaged about 120 basis points in September 2011, which is elevated, but still slightly below levels seen during the recession scare in June and July 2010. As a signal, the slope of the yield curve between ten years and three months is also distorted by the present near-zero interest-rate policy, which prevents yield-curve inversions. For this reason, the model also includes the level of the ten-year Treasury yield and core inflation to reflect the Japan-like near-zero long-term real return expectations on the Treasury bond.

The figure below shows the model-implied business cycle index, where its distance from zero indicates either the depth of a recession or the strength of an expansion. The history of the business cycle index illustrates the so-called Great Moderation in the U.S. economy after 1984. The out-of-sample forecasts in the chart suggest that the central-tendency forecast is a muddle-through scenario, with gradual, achingly-slow improvement in business cycle conditions that never reach anything beyond what could be called mediocre.

The distance from zero indicates the depth of a recession or the strength of an expansion.


As part of his recession call, Lakshman Achuthan of the Economic Cycle Research Institute has said that he would not be surprised at all if the U.S. unemployment rate were to go back above 10 percent, presumably as part of its current trajectory without requiring fresh shocks to push it there. The central-tendency forecasts of nonfarm payroll employment from the Qual VAR model, in contrast, do not project the declines in employment that would be part and parcel of a new U.S. recession. In particular, the path of employment shown here is not consistent with a rise in unemployment back to 10 percent. Instead, the projection is for U.S. jobs gains to remain moribund for several months, not reaching 150,000 jobs per month on a sustained basis until June 2012. Thus, it will be hard to distinguish in coming months between a stalling economic expansion and an economic expansion that is slowly rebuilding momentum from scratch. Nevertheless, the key difference in message between the Qual VAR model and ECRI concerns whether new negative shocks are needed to drive the U.S. economy into recession or not.

Forecasts for nonfarm payroll employment starting in October 2011 from Qual VAR model.


I emphasize that a U.S. recession is certainly possible, given that a Eurozone recession looks very likely. It is entirely conceivable that European policymakers will fail to gather the necessary resources in time to prevent financial-market contagion to peripheral countries, such as Italy and Spain, or to recapitalize their banks sufficiently quickly in the face of or, better yet, in advance of a Greek default. Such a financial shock, if it occurs, could be transmitted to the United States with sufficient severity to lead to recession here. This would be a new negative shock, however, and does not appear to be built into current early-warning financial indicators in the United States to a sufficient degree to make a U.S. recession the base case at this time. My current reading of the financial market indicators of the U.S. business cycle is that investors are more concerned about Japan-style economic stagnation right now than about a traditional recession.

Is another U.S. recession a ‘done deal’?
James Hamilton
Sat, 08 Oct 2011 20:39:05 GMT


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