Clarifying the Recession Probability Indicator

The other day I posted an article using a St Louis Fed recession probability chart that was based on the work of Marcelle Chauvet & Jeremy Piger.   I used the real-time data to imply that there was perhaps a reliable extrapolation to be made.  That was not correct and was a bit hyperbolic of me to imply.

I should have looked into the sources further before citing it because Marcelle Chauvet reached out to me personally to clarify how to use this indicator:

Dear Cullen,

Thanks for your article on the probabilities of recession.

I would like to clarify some points.

My paper with Piger published in 2008 is based on my International Economic Review 1998 paper, which proposes the model used in Chauvet and Piger — I have been running this model in real time since 1993.

The probabilities of recession posted on Fred are ‘smoothed probabilities’, that is, smoothed away from all past kinks that we find in real time.

Real time probabilities are very noisy, and a little bump of 15%, 20% or even 30% does not mean much in terms of signaling recessions.

Please check the graph on real time probabilities of recession on my site:

sites.google.com/site/crefcus/probabilit…

These are the probabilities we get on a month-to-month basis, without data revisions, and without smoothing. As you can see, the probabilities can even be above 50% and a recession does not follow.

This is why in my paper with Jeremy we set the rule that the probability would have to be above 80% and for a couple of months before one could call a recession.

Best,

Marcelle Chauvet

Thanks for that clarification, professor.  This is actually much more in-line with what I am seeing in proprietary indicators because it means the current readings in the indicator are not a clear sign of recession.   Sorry for any confusion I might have caused.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • LVG

    Good clarification. Thanks for passing this on.

  • Tom

    Any idea why there seem to be so much data out of the St louis fed on economics and the other regional banks have so little I see cited in the financial blogosphere?

  • flow5

    “so much data out of the St louis fed on economics”

    It’s traditional. The St. Louis Fed was formally thought of as a maverick bank (see: Business Week article reprint November 18, 1967)

    http://research.stlouisfed.org/conferences/homer/maverick.pdf

    “St. Louis bank preaches that it’s quantity of money, not cost, that counts…as the Fed traditionally views it, monetary policy bites mainly through interest rates. But St. Louis leans toward the quantity theory of the Chicago school and its leader, Milton Friedman. This holds that changes in the quantity of money, not the cost of money, are what really count”

    See also: Lawrence K. Roos, Past President, Federal Reserve Bank of St. Louis & past member of the FOMC (the policy arm of the Fed) as cited in the WSJ April 10, 1986 “…I do not believe that the control of money growth ever bec ame the primary priority of the Fed. I think that there was always & still is, a preoccupation with stabilization of interest rates”.

    I.e., Keynes’s liquidity preference curve (demand for money) is a false doctrine. The money supply can never be managed by any attempt to control the cost of credit.

  • http://www.nowandfutures.com bart

    Time will tell on the recession indicator.

    And do note that it does use Markov switching, part of whose purpose is smoothing of volatile data series.

  • Cowpoke

    Here’s a REAL recession indicator for yall:

    Last night’s victory for the President marks the first time since its inception that Obamacare is no longer a what-if; it is the future of health care in America.

    It also means a near immediate impact on the economy. With 20 or so new or higher taxes set to be implemented, ranging from a $123 billion surtax on investment income, through the $20 billion medical device tax, all the way down to the $600 million executive compensation limit, Obamacare will be a nearly unbearable tax burden on the economy.

    Who will pay? The middle-class workforce, of course.

    So with another four years for President Obama to look forward to, and the obvious inevitability of Obamacare that this entails, let’s examine the very real jobs that will be lost, and the very real lives that will be affected.

    Welch Allyn

    Welch Allyn, a company that manufactures medical diagnostic equipment in central New York, announced in September that they would be laying off 275 employees, or roughly 10% of their workforce over the next three years. One of the major reasons discussed for the layoffs was a proactive response to the Medical Device Tax mandated by the new healthcare law.

    Dana Holding Corp.

    As recently as a week ago, a global auto parts manufacturing company in Ohio known as Dana Holding Corp., warned their employees of potential layoffs, citing “$24 million over the next six years in additional U.S. health care expenses”. After laying off several white collar staffers, company insiders have hinted at more to come. The company will have to cover the additional $24 million cost somehow, which will likely equate to numerous cuts in their current workforce of 25,500 worldwide.

    Stryker

    One of the biggest medical device manufacturers in the world, Stryker will close their facility in Orchard Park, New York, eliminating 96 jobs in December. Worse, they plan on countering the medical device tax in Obamacare by slashing 5% of their global workforce – an estimated 1,170 positions.

    Boston Scientific

    In October of 2009, Boston Scientific CEO Ray Elliott, warned that proposed taxes in the health care reform bill could “lead to significant job losses” for his company. Nearly two years later, Elliott announced that the company would be cutting anywhere between 1,200 and 1,400 jobs, while simultaneously shifting investments and workers overseas – to China.

    Medtronic

    In March of 2010, medical device maker Medtronic warned that Obamacare taxes could result in a reduction of precisely 1,000 jobs. That plan became reality when the company cut 500 positions over the summer, with another 500 set for the end of 2013.

    Others

    A short list of other companies facing future layoffs at the hands of Obamacare:

    •Smith & Nephew – 770 layoffs
    •Abbott Labs – 700 layoffs
    •Covidien – 595 layoffs
    •Kinetic Concepts – 427 layoffs
    •St. Jude Medical – 300 layoffs
    •Hill Rom – 200 layoffs
    Beyond the complete elimination of a significant number of American jobs is another looming problem created by the health care law – a shift from full-time to part-time workers.

    http://www.freedomworks.org/blog/grusbf5/good-morning-america-heres-those-layoffs-you-voted