Wednesday, September 12, 2007

A Recession Coming Our Way?

A reader of this blog has asked whether I think the U.S. economy faces an impending recession. I will refrain from making my own judgement call and instead turn to the collective wisdom of the markets. I direct you first to intratrade's contracts (hat tip Greg Mankiw) on the probablity of a recession in 2007 and 2008. Take a look at the 2007 contract in the accompanying figure. The probability (price = probability) for a recession in 2007 has declined since the beginning of the year from 35% to just under 15%. It is interesting to note, though, that there is a spike in September. I suspect this reflects the bad employment news last Friday. It will be interesting to see if this September spike is noise or the beginning of a trend based on the understanding the U.S. economy may already be in a recession. Intratrade has a related contract that directly addresses this possibility: the 2007:Q4 GDP growth will be negative contract. As of today, the probability is at 26%.

Now take a look at the 2008 contract in the figure below. According to this contract there is as of today (September 12) a 55% chance of a recession in 2008. The entire month of September has seen an steady climb in the contract price or probability of recession. Historically, when odds have reached this high using the yield curve spread as a predictor of recessions there almost always has been a recession. To the extent these results carry over to prediction markets it seems safe to conclude that a recession is inevitable. Given this future, let's hope the Economist's provocative claim that a recession is good for the economy is on the money.

For a different take on the matter, I point you now to an article in Barron's titled "Recession May Begin Within 12 Months":

... To put a number on it, we estimate that the probability of recession is roughly 60%. This assessment is based on four factors: the behavior of the Treasury curve, the deterioration in the labor market suggested by the household survey, the turmoil in the credit markets that suggests an end to a period of rapid credit creation, and our outlook for the housing market.

Then there is our good friend Nouriel Roubini who chimes in with these words:

The utterly ugly employment figures for August (a fall in jobs for the first time in four years, downward revisions to previous months’ data, a fall in the labor participation rate, and an even weaker employment picture based on the household survey compared to the establishments survey) confirm what few of us have been predicting since the beginning of 2007: the U.S. is headed towards a hard landing.

The probability of a US economic hard landing (either a likely outright recession and/or an almost certain “growth recession”) was already significant even before the severe turmoil and volatility in financial markets during this summer. But the recent financial turmoil - that has manifested itself as a severe liquidity and credit crunch - now makes the likelihood of such a hard landing even greater.

... the forthcoming easing of monetary policy by the Fed will not rescue the economy and financial markets from a hard landing as it will be too little too late... Fed easing will not work for several reasons: the Fed will cut rate too slowly as it is still worried about inflation and about the moral hazard of perceptions of rescuing reckless investors and lenders; we have a glut of housing, autos and consumer durables and the demand for these goods becomes relatively interest rate insensitive once you have a glut that requires years to work out; serious credit problems and insolvencies cannot be resolved by monetary policy alone; and the liquidity injections by the Fed are being stashed in excess reserves by the banks, not relent to the parts of the financial markets where the liquidity crunch is most severe and worsening.

Hang in there America as we weather this economic storm.

3 comments:

  1. This is a cop-out response, Professor Beckworth. You're supposed to tell us what your gut says. That's how government policy is conceived these days.

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  2. Oh my. I guess we shouldn't be heeding economists' predictions anyway.

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  3. Brian,

    I was told in graduate school that economic forecasting is to economics what astrology is to mainstream religion. That left quite an impression on me.

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