Calling Recessions in Real Time
James D. Hamilton
Dept of Econ, UCSD
I. Overview of some of the issues
II. Track record of alternative approaches
Date of recession Announcement lag
peak trough peak trough
Jan 1980 Jul 1980 5 months 12 months
Jul 1981 Nov 1982 6 months 8 months
Jul 1990 Mar 1991 9 months 21 months
Mar 2001 Nov 2001 8 months 28 months
Is our objective to:• predict at t whether we will be in a
recession at t + j or• predict at t whether we were in a recession
at t - j
Theme: It’s very hard even to do (2) in real time.
Why should it be hard?
(1) recessions result in part from forecast errors
(a) Fed misjudges economy
(b) Firms misjudge markets
(2) economic relations change over time
June labor force participation rate (women aged 35-44)
30405060708090
1945 1955 1965 1975 1985 1995 2005
June labor force participation rate (men aged 45-54)
405060708090
100
1945 1955 1965 1975 1985 1995 2005
Why should it be hard?
(1) recessions result in part from forecast errors
(2) economic relations change over time
(3) data revisions
Source:Leamer (2008)
Nonfarm payroll employment as reported on different dates
What is the definition of a recession?Possible answers:
A. Ad-hoc qualitative summary of observable data (e.g., 2 quarters of falling real GDP)B. It’s a recession if and only if the NBER says soC. A recession is an objective but unobserved determinant of the data
I. Overview of some of the issues
II. Track record of alternative approaches
A. Predicting an ad-hoc event
Ray Fair (1993)
y1t GDP growth in quarter t
S t 1 if y1t 0 and y1,t 1 0
0 otherwise
yt c 1yt 1 pyt p tmodel implies
PrS t j 1|yt,yt 1, . . . .
Stock-Watson experimental
recession index (1988-1993)
yt L c t utDLut t L c t tS t 1 if c t s s 0
8 BtBt inferred to approximate NBER
In-sample: P(t|t)
In-sample: P(t+3|t)
In-sample: P(t+6|t)
Out-of-sample: P(t+6|t)
Out-of-sample: P(t+3|t)
Out-of-sample: P(t|t)
Recession began: July 1990P(t|t) > 0.5 by Nov 1990
I. Overview of some of the issues
II. Track record of alternative approaches
A. Predicting an ad-hoc event
B. Predicting what the NBER is going to say
PrS t j 1|yt Fyt; Choose F. and ytEstimate
Interest Rates• FF Federal Funds rate• 3M 3-month Treasury Bill rate• 5Y 5-year Treasury Bond rate• 10Y 10-year Treasury Bond rate• AAA Moody's corporate bond yield• AA Moody's corporate bond yield• A Moody's corporate bond yieldTerm Spreads• TS10YFF 10Y-FF Treasury term spread• TS10Y3M 10Y-3M Treasury term spread• TS10Y5Y 10Y-5Y Treasury term spreadCredit Spreads• CSAAA AAA - 10Y spread• CSAA AA - 10Y spread• CSA A - 10Y spreadEmployment Data• EMP Δ log non-agricultural employment• CEMP Δ log civilian employment• UICLAIM Δ log unemployment claims• UNEMP Unemployment rate• UNEMPD Change in unemployment rate• HOURS Δ log manufacturing hours
Stock Price Indices• DJ30 3-mo Δ log Dow Jones 30 average• SP500 3-mo Δ log S&P 500 stock price
indexMonetary Aggregates• M0 Monetary base (log-differenced)• M1 (log-differenced)• M2 (log-differenced)Other Macroeconomic Variables• CLI11 Δ log composite leading indicators• CPI, all urban, all items (log-differenced)• EXP Consumer expectation• EXPD Changes in consumer expectation• HOUSE Building permits (log-differenced)• VENDOR performance • INCOME Δ log personal income• IP Industrial production (log-differenced)• SALES Δ log Manufacturing & trade sales
Katayama (LSU, 2008)
Evaluated with 7 different choices for F(.) by post-sample and leave-2-years-out cross-validation
Conclusion:Improvements from F(.) with positive skew and
excess kurtosis
Best variables:• 10Y-3M treasury spread• S&P500 3-month growth• employment growth
Chauvet and Potter (2002, 2005)
Probit specification based on term spread allowing for serial correlation and structural breaks successfully predicted 2001 recession
Wright (2006)
• F(.) ~ Normal
• 10Y-30M treasury spread
• fed funds rate
• tries to predict an NBER recession any time within next 12 months
Leamer (2008):
Choose thresholds for 6-month changes so as to fit NBER dates
I. Overview of some of the issues
II. Track record of alternative approaches
A. Predicting an ad-hoc event
B. Predicting what the NBER is going to say
C. Recognizing a shift in the observed dynamics of economic variables
y t GDP growth for quarter t
S t 1 if recession at t
0 if not recession at t
y t s t t t N0, 2S t unobserved
PrS t j|S t 1 i p ij
Density of expansions
0
0.05
0.1
0.15
-15 -12 -9 -6 -3 0 3 6 9 12 15
GDP growth
Density of recessions
0
0.05
0.1
0.15
-15 -12 -9 -6 -3 0 3 6 9 12 15
GDP growth
= 4.7 = 3.5
= -1.2 = 3.5
Density of mixture
00.020.040.060.08
0.10.12
-15 -12 -9 -6 -3 0 3 6 9 12 15
expansion
recession
mixture
Density of mixture
00.020.040.060.08
0.10.12
-15 -12 -9 -6 -3 0 3 6 9 12 15
expansion
recession
mixture
)2|()2Pr(),2Pr(
),2Pr(),1Pr(
),2Pr(
)(
),2Pr()|2Pr(
ttttt
tttt
tt
t
tttt
SyfSyS
ySyS
yS
yf
ySyS
Density of mixture
00.020.040.060.08
0.10.12
-15 -12 -9 -6 -3 0 3 6 9 12 15
Probability of recession
00.20.40.60.8
1
-15 -12 -9 -6 -3 0 3 6 9 12 15
GDP growth in quarter t
Filter inference:
PrS t 1|y t,y t 1, . . . ,y1Smoothed inference:
PrS t 1|yT,yT 1, . . . ,y1
Contributions to percent change in real gross domestic product
-2
-1
0
1
2
3
4
5
6
2007:Q3 2007:Q4 2008:Q1 2008:Q2
GDP
Consumption
Nonresidential fixed investment
Residential fixed investment
Change in inventories
Exports
Imports
Government
Ft s t Ft 1 tyrt rFt vrtvrt rvr,t 1 rt
yt
ln sales
ln pers income
ln civ employ
ln ind prod
Chauvet and Hamilton (2006), Chauvet and Piger (2008)
Month Probability of Recession
February 2008 15.4%
March 2008 16.0%
April 2008 15.6%
May 2008 15.3%
June 2008 14.0%
July 2008 13.0%
Source: Jeremy Piger, Sept. 29, 2008
Source: Jeremy Nalewaik
Source: Jeremy Nalewaik
Hamilton (2005)
y t unemployment rate
y t cs t 1y t 1 2y t 2 t
S t
1 if expansion
2 if mild recession
3 if severe recession