leading economic indicators

[Jim Devine <jdevine@xxxxxxxxxxxxxxx>]

Someone (Rob Schapp?) asked about the leading economic indicators' fall and
whether or not they indicated a possibility of a US recession in the near
future. I'm no fan of such indicators, since they seem to indicate more
possible recessions than actually happen.

One of the better ones is the shape of the Treasury yield curve: usually,
if short-term interest rates are higher than long-run ones (when the yield
curve is "inverted"), it's a sign of recession in the future. Current tight
monetary policy drives up short rates, while long rate don't change much,
while tight policy encourages recession. (This doesn't work if a recession
is caused by restrictive  fiscal policy, falls in consumer or corporate
borrowing, or falls in net exports.) Alternatively, low long-term rates may
reflect expectations that short-term rates will be low in the future,
suggesting a fall in the demand for money in the future (a recession).

Currently, the yield on long-term Treasury bonds are low compared to
short-term rates. The Federal Reserve of St. Louis (or rather, the author
of the article in their August 2000 MONETARY TRENDS, Christopher Neely)
says that using the rates on 10-year Treasury bonds implies a 20 percent
chance of a recession in the next year, significantly higher than normal.
On the other hand, using AAa corporate bond rates suggests only a 10
percent chance of recession. It's not normal to see this kind of deviation
between the predictions. It probably arises because the Treasury has been
buying up long-term bonds, driving up their price and lowering their yield.

As Neely says, the slope of the yield curve does pretty well at forecasting
compared to other methods. However, this method didn't predict the 1990
recession, while predicting recessions that didn't happen (e.g., 1967). As
with the Conference Board's leading indicators, the yield curve doesn't do
well if the structure of the economy changes.

Is there going to be a recession? Yes. When is it going to happen? I don't
know. Should we start cashing in our stocks and bonds and buy canned food
and guns instead? If that's what turns you on ....

Jim Devine jdevine@xxxxxxx &  http://bellarmine.lmu.edu/~jdevine