When the economy reaches stall speed

If an airplane is moving too slowly, the plane is about to head down. Federal Reserve economist Jeremy Nalewaik has an interesting new paper exploring whether the same is true for the U.S. economy.

Nalewaik notes first that the 4 quarters prior to recessions were usually characterized by slower real GDP growth than is typically observed in an economic expansion.

Estimated density of real GDP growth in the 4 quarters prior to an economic downturn (dashed blue) and all other quarters characterized as economic expansion (solid red). Source: Nalewaik (2011).

He then estimates Markov-switching models in which there may be an intermediate phase the economy moves into before or after an economic recession. This approach allows for a variety of possible outcomes. For example, it could capture a phase of rapid GDP growth in the first few quarters of a recovery, as proposed by Sichel (1994). However, Nalewaik usually finds evidence of a “stall” phase that the economy enters before going into a full-blown recession. For example, real GDP might be expected to grow at only a +1 to +2 percent annual growth rate per quarter while in the stall phase, before falling outright at a -1 to -2 percent rate during a recession. Unemployment in the stall phase might be expected to increase by 0.1% per quarter, before rising at 0.6% per quarter once the recession proper begins. The graph below shows the inferred probability that the economy was in the stall phase and the recession phase as inferred from unemployment dynamics.

Probability (reported as percent out of 100) that the U.S. economy was in the stall phase at any given date (solid) and in an economic recession (dashed) as inferred from unemployment rate alone. Shaded regions correspond to NBER recession dates (not used in estimation). Source: Nalewaik (2011).

The figure above represents an inference based on the full sample of data as subsequently observed. It is a trickier business to construct real-time forecasts with this approach. Slow economic growth or gradually rising unemployment sometimes is a precursor for a recession, but sometimes it’s just a temporary hiccup before more robust growth resumes. Nalewaik recommends a more detailed model for forecasting that makes use of other leading indicators such as the slope of the yield curve or housing starts.

And of course the big question right now is whether the recent sluggish growth could turn out to be part of another pre-recession stall phase. The yield curve is steeply sloping up at the moment. In normal times that would be a favorable indicator, but it’s pretty hard to interpret in the current setting with the short-term interest rate artificially stuck at zero. Housing starts are likewise of limited help at the moment since residential construction has been dead for so long.

My position remains that recent slow growth rates do not signal a coming recession, but that slow growth is a very painful and unsatisfactory outcome given the current high levels of unemployment. Nalewaik’s research gives us another reason to be concerned about forecasts of sluggish growth in 2011.

22 thoughts on “When the economy reaches stall speed

  1. spencer

    Remember that the consensus never forecast a recession. Going into a recession the consensus
    alway6s forecast a significant slowdown followed by some strengthening.
    I actually have a theory that it is impossible for the consensus to successfully forecast a recession.

  2. Nemesis

    Based on the rate of change of oil consumption to real private per capita GDP and industrial production, the current business cycle peaked in Q2-Q3 ’10, stalled in Q1, and is now on the recession slippery slope as I type.
    The Japanese quake and tsunami, tornadoes and floods in the US, energy shortages emerging around the globe, accelerating annualized and yoy price inflation, especially in China-Asia, $100-$115 oil, and shrinking profit margins are the necessary precursors for a global deflationary contraction into year end and early ’12.
    During a debt-deflationary regime, a steep yield curve does not imply a new reflationary growth cycle, as bank charge-offs and delinquencies as a share of loans exceed banks’ net interest margin, which discourages a net increase in bank lending.
    Industrial output and aggregate consumer demand growth, with higher structural unemployment (and an emerging demographic drag today), is at higher risk of shocks to margins, incomes, and supply chains.
    We have already passed the point of no return for another cyclical contraction of real per capita private GDP, which will become apparent by mid- to late summer.

  3. Steven Kopits

    As I read it, Nalewaik uses a number of different approaches to determine if the economy’s stall speed can be determined ex-ante.
    The appropriate metric for such an approach would include:
    – no false positives (if it indicates a recession, one actually occurs)
    – no false negatives (never misses a recession)
    – lead time less than two years but greater than zero(to predict a recession five years in advance is hardly helpful)
    I read the methodologies associated with figures 7 and 8 as best meeting these criteria. Both these charts, using indicators from Q3 2010, suggest another recession within two years on the outside, if I am reading the graph correctly.

  4. mclaren

    The reason for another recession seems evident: constantly rising oil prices (Deutsche Bank analysts predict $175/bbl by 2016) combined with the end of the fiscal stimulus, plus constant offshoring of America’s remaining high-paying white collar jobs.
    “In the years ahead, sizable numbers of skilled, reasonably well-educated middle-income workers in service-sector jobs long considered safe from foreign trade—-accounting, law, financial and risk management, health care and information technology, to name a few—-could be facing layoffs or serious wage pressure as developing nations perform increasingly sophisticated offshore work.”
    Source: “The Big Squeeze,” NEWSWEEK European edition, 30 May 2010.

  5. Ignacio

    I think that the growth due to manufacturing correction is done, and that may explain sluggish growth now. It is the time for services taking the lead, but if services falter…

  6. ivars

    I think the fact that recession is coming is beyond any doubts since QE2 started, as economy is stimulated,on a life line from FED, and , if the growth produced from QE2 is too slow ( as it is in Q1, Q2), stimulus will dry out (inflation + unsustainable debt will kill it).
    So the real question people should be asking is what to do in case of second recession in q1 2012-2013 and how to default on USA debt , what is the best way? That is not so far away-plans are already almost too late to draw…
    Europe is already trying/discussing defaulting scenarios of its parts , in that sense they are closer to reality, although sticking to EUR may cause them to default as a whole as Strong core will not be able to bail out all periphery, i.e. Europe as a whole does not look better as the USA as a whole.
    As to Japan, that is clearly the weak link in Western model, a very dangerous case of number 2-3 economy rapidly loosing position. That will incite appetite of China for Japanese technology acquisitions and general more aggressive stance in the region as former Western model risk on marvel starts to inevitably shrink. Its bad to have weak links in any system ( remember Ottoman empire before WWI – the weak link in Imperial system that caused WWI because other rising powers (Germany) wanted to get benefit from its weakness).

  7. JBH

    The only approach that has worked in real time is leading indicators; they work with a stunning degree of accuracy. And not the Conference Board’s composite, which is inferior in composition and in lead time. Moreover, it is necessary to use one set of leading indicators at business cycle peaks to predict recessions and a different set at troughs to predict recoveries. Further, the lead time is far shorter at troughs and much tighter in terms of accuracy in calling the date of recovery.

    One of these indicators is the stock market, a key leader at both peaks and troughs. That the stock market sometimes gives false signals (on its own) is not to be held against it. Obviously if it were a perfect leader the whole point of this paper would be pretty much moot. You will deduce from this that Samuelson’s barb about the stock market having called something like 10 of the last 6 recessions was quite misleading. At peaks the lead time for the stock market is on the order of nine months. Since the market’s potential top for the current cycle is here in May, that makes the likelihood of a recession this year quite slender. The yield curve is a powerful predictor, and I give the current shape of the yield curve a lot of weight in opining no recession on the near-term horizon. Whether or not the fed funds rate is “artificially” stuck at zero, a normally-sloped curve speaks to a deeper truth, that truth being the underlying causal reason why the yield curve works as a leading indicator. Mostly I believe it has to do with the spigot at the beginning of the credit creation process being open or closed. Obviously wide open today.

    There is also something important about being in the early stages of a recovery, especially after such a severe recession. At the end of the cycle various parts of the economy are in a state of exhaustion. A shorthand way of saying this that gets at the underlying reality, like quarks to the workings of the atom, is demand satiation. The state of the system today is just the opposite — one of extreme pent-up demand. Pent-up demand is a vital economic construct for which no suitable mathematical representation has ever been developed according to my knowledge. Ditto for demand satiation. The obvious if not easily measurable degree of today’s pent-up demand bolsters your position that the current state of slow growth does not signal coming recession, Dr. Hamilton. For these reasons, barring some catastrophic event like a toppling of the Saudi government, the next recession will be a long time coming. Growth on the order of 2.5% (or less) is by far the most likely prospect this year and next. The economy is under far too many constraints (e.g. deleveraging, broken monetary transmission mechanism, anti-business administration) for it to be otherwise. What makes this “slow” rate of growth so pernicious is that the current socially unacceptable high rate of unemployment will not go down unless the economy grows faster than 2.5%. Or if it does it will be on a painfully slow trajectory.

    Might I then suggest a new posting at some future date soliciting well-thought-out solutions from your readers on what to do about this slow growth state of affairs, limiting them to perhaps one per reader so as to harvest only the kernels and not the chaff? That could be followed up by further postings prioritizing the results, and then in tree-like fashion a discussion of the pros and cons of each. All of us would learn a lot from the collective creative imagination of the group in this manner.

  8. spencer

    The stock market is a great leading indicator or recessions. It has forecast nine of the last six recessions.

  9. MarkS

    I read with considerable amusement, the wide deviation in opinion about the current probability of a recession in the near future.
    My viewpoint is very fundamental. The probability for a near-term recession is entirely dependent on Federal Reserve Quantitative Easing and Federal Government Deficit Spending… Most intelligent people recognize that the end of the line for both behaviors is rapidly approaching, if the US wants to protect its privileged position of controlling a global reserve currency… I can’t say with certainty that the desperate pump-priming will dissipate in the next three months, but if you take the FED and the Republican Party at their word, the rug will soon be pulled out from under the current “recovery”.
    Longer term, the severe headwinds associated with supply limitations for natural resources, over-leverage in the credit markets, loss of manufacturing in many industries, and population aging will act like a huge load of ballast, impeding economic expansion for decades into the future. It may indeed be true, that actual contraction of the real productive economy will continue in the US over the next few decades, depressing wages and government services until the relative cost structure with trading partners improves significantly.

  10. Ekim

    Qualitative analysis should be added to the study. That is, differentiate between productive activity and unproductive activity. Unproductive activity, such as building the wrong mix of homes for the market, will result in a future slowdown.
    The market uses price signals to determine demand. Distorting price signals via excessive printing of credit tricks the market into thinking sustainable demand exists where there is none. This comes at a future price. Loans extended for unproductive activity cannot be repaid, because the products will not sell. There is no demand for products priced above marginal utility, once the Minsky credit mania phase recedes. That is, consumers are not willing to work 2 jobs plus overtime to make payments on McMansions that they cannot afford.
    To put this another way, leveraged financial bubbles are counter productive in the long run. A temporary boost to activity will be followed by a slowdown of equal and opposite magnitude. Productive activity must be stimulated for a recovery to be sustainable in the long run.

  11. CoRev

    JDH, I agree with this statement: “…anti-business administration)”. Inconsistent and overwhelmingly negative/anti-business messages from this administration causes uncertainty and lack of confidence in the administration slowing the recovery. Obama has surrounded himself with like thinking advisers, so it is hard to break through their anti-business shell.
    Sad, actually. The wrong team for these times. My number one solution: CHANGE THE TEAM.

  12. 2slugbaits

    CoRev JDH, I agree with this statement: “…anti-business administration)”.
    JDH did not say that. It was a poster with similar initials, JBH.
    If you want to change a team, get rid of the GOP clowns in Congress that are standing in the way of additional fiscal stimulus and are making it all but impossible for the Fed to launch QE3. And you might want to look at business profits along with the run-up in equity prices and ask yourself if Obama is really “anti-business.” It’s a ridiculous charge straight from Fox News.
    I’ll take this opportunity to restate some advice that I keep giving you. Take an economics class at a local college and learn the difference between demand curves and supply curves.

  13. CoRev

    2slugs, and I’ll give you some advice. Take a Poly Sci course and learn about countervailing forces and some of the other fundamentals of politics. You might then understand dhow and why nearly all legislation is made of compromises.
    Please, QE3 and then QE4 … and on until we no longer have to collect taxes we can just live off the interest on the Fed holdings.
    BTW, don’t make me pull anti-business quotes made by the Democratic “team.” We can attack the issue by industry if you wish a method for organizing them. Perhaps you forgot last week’s “Big Oil” hearing? Or the attacks on the health insurance industry. The auto manufacture hearings. Big Pharma, banking, and Boeing were targets also, and even that list is incomplete.
    2slugs, your hubris is awe inspiring. That comment was definitely worth a SHEESH! I don’t often capitalize it!

  14. 2slugbaits

    CoRev 2slugs, and I’ll give you some advice. Take a Poly Sci course
    Been there, done that. In fact, one of my first undergraduate degrees was in political science.
    You might then understand dhow and why nearly all legislation is made of compromises.
    I haven’t seen any evidence that the GOP is interested in compromise. As I recall a poll among Republicans found that they did not want their GOP candidates to compromise at all. Teabaggers don’t do compromise. But setting aside the issue of political compromise there is also the technical question of what the economy needs; and it needs more fiscal stimulus and QE3.
    We can attack the issue by industry if you wish a method for organizing them.
    All of those industries are doing pretty well, so evidently any “anti-business” talk doesn’t seem to have much practical effect on profits. One of the industries you mentioned was auto manufacturing. Gee, weren’t you opposed to the auto industry bailout? So you think Obama is opposed to the auto industry? But the other industries you cited (Big Pharma, banking, health insurance and Boeing) make their money the old fashioned way…they carve out monopoly rents. There’s nothing wrong with restricting rents.
    JDH’s post was about the recovery stalling before there is a turning point towards a recession. In some way I think the problem might be misstated. Instead of thinking about the US experience of a Great Depression or a Great Recession, perhaps we should think like the British and adopt the term Great Slump. A prolonged slump rather than a severe downturn seems the most likely outcome right now. And it’s frustrating because it was all avoidable. Why didn’t God give Republicans brains?

  15. CoRev

    2slugs claims: “All of those industries are doing pretty well, so evidently any “anti-business” talk doesn’t seem to have much practical effect on profits.” Since we are talking about two subjects here: 1) anti-business politics/talk; and 2) business profits, it might be interesting to dissect whether a large percentage of the profits are coming from inside or outside the US.
    Furthermore, if industry chooses to invest outside the country to increase that area of their profits, we might want to study the reasons why that might be on going. It is not uncommon to see industry move to pro-industry environs from those less so. Y’ano like Boeing?
    These above are just conjectures, but the following is not. Of the three US auto makers only Ford did not take the buy out. Ford was also the first to turn a profit. It is not uncommon to see industry move to pro-industry environs from those less so. Y’ano like Boeing, and the multiple US and foreign auto plants operating in the right to work states.

  16. CoRev

    Interesting follow-on to my previous comment. Cavuto interviewing the CEO of Heinz. CEO says they just bought a company in Brazil. Cavuto asks why there and not here? CEO answers no growth here. Cavuto asks about company moves within the US and they discuss the SC/NLRB/Boeing issue. CEO then goes on to say if the restrictions continue, then he expects to see companies move even more jobs over seas.
    But, some feel this administration is not anti-business or at least not business friendly.

  17. 2slugbaits

    CoRev Ford was also in the best shape going into the recession, which is why they didn’t take the TARP money. So it’s not exactly a surprise that they would be the first to turn a profit. But the key point is that if McCain and the GOP had won in 2008, then GM and Chrysler would be long gone by now. Is that your idea of “business friendly?” In normal times I would have opposed the bailout, but that opposition would have been based on micro foundations. In this case the macro upside of bailing out GM and Chrysler outweighed (by far) the microeconomic downsides.
    Like a lot of conservatives without formal training in economics, you don’t seem to understand the difference between economic growth and just plain old cost shifting. Moving jobs from point A to point B doesn’t create growth overall unless it results in increased effective demand overall ala Says Law. But that’s not happening today. The central problem today isn’t unit labor costs, it’s excess capacity given weak demand. That’s what JDH and Menzie have been talking about for the last couple of years. You need to put down those RBC goggles and understand the central economic problem we’re facing today. This is not 1979.

  18. 2slugbaits

    CoRev When I said that Boeing made its money the old-fashioned way…monopoly rents, this is what I had in mind:
    My team actually worked this issue as a very small part of a broader study back in 2007-2009 and we fed the results to the DoDIG. BTW, this audit was released on 3 May and last week I was in Corpus Christi meeting with the depot commander to let him know that another shoe (actually three more shoes) are about to drop.
    CEO answers no growth here.
    What part of “no growth here” did you not understand? “No growth” means no demand. And again, shifting jobs from point A to point B is not economic growth. What part of that do you not understand? There is nothing “business friendly” about GOP fiscal policies that doom us to a perpetual 3% output gap.

  19. CoRev

    2slugs,your spinning yourself into the ground again with your “I” was part of a study (not related to any matter discussed here), and you’re arguing by assertion with this: “But the key point is that if McCain and the GOP had won in 2008, then GM and Chrysler would be long gone by now”.
    You really should look at the history of Saginaw Steering Gear to Delphi to their current name. Still in business. Not long gone, and more representative of the auto industry than your assertions.
    Yes, Ford was a marginally better managed company than GM and Chrysler, but they had the same opportunity and risk with taking stimulus funding, and they chose the better route. Bidness doing bidness and not government doing bidness where it shouldn’t.
    You end with more argument by assertion: “There is nothing “business friendly” about GOP fiscal policies that doom us to a perpetual 3% output gap.” Maybe because of your hubris you think this kind of argument is meaningful. It’s not!
    You’re back into sheesh territory, so I’m out of here.

  20. 2slugbaits

    CoRev (not related to any matter discussed here)
    Not related??? Excuse me, but I was talking about Boeing’s business model and you were the one who brought up Boeing. Maybe you think catching a big defense contractor engaging in fraud is not sufficiently “business friendly.” That was my point. Do you think we should allow companies to screw taxpayers out of concern that clamping down on fraud might be seen as contributing to an anti-business climate? And I suppose you would support “business friendly” tax subsidies that encourage the exporting of jobs? Hey, that’s a “business friendly” policy that the GOP seems to approve of.
    And what does your pithy Saginaw Gear/Delphi story have to do with macroeconomic policy? A company goes bankrupt and sells off a piece to another company that also has a great idea. Nice story, but also irrelevant to fiscal and monetary policy issues.
    On the other hand, worrying about sustained and large output gaps is highly relevant, but all you can do is let out a loud “sheesh.” Seriously, do you understand the difference between nice little business stories and macroeconomics? Hint…if you listen to Neil Cavuto, then the answer is probably “no.”

  21. Philip George

    There is a far better indicator of the coming recession: money. Of course you need the right monetary aggregate.
    Take a look at http://www.philipji.com/item/2011-05-11/how-much-longer-until-a-crash to see how close the current value of the monetary aggregate (Corrected Money Supply) is to its peak at the beginning of 2006. In that case, it took nearly two years for the recession to begin because most housing loans were issued with teaser rates and the real rates did not kick in for two years.
    This time I am pretty confident there won’t be such a lag.
    The coming recession will occur for pretty much the same reason as the last one. Low interest rates have made it highly profitable to speculate and to lend to speculators. I wonder how many of the big banks (and shadow banks) will go under this time.
    When you really think about it there is no rationale for low interest rates except the arguments of J.M. Keynes. And his rationale, if one can call it that, was that in advanced economies with a lot of accumulated capital the marginal efficiency of capital is so low that it needs very low interest rates to stimulate investment. I wonder what he would have made of the fact that the US is still one of the biggest FDI destinations.
    Also, come to think of it, why did Walter Bagehot say: “Lend freely at a high rate, on good collateral.” Note the “high rate”.

  22. dennis

    Debit owed to social security, is not a debt owed by the federal government to it self, it is owed to all retired, future retires, and disabled people paid up front and each year by the people! There would be no chance of running out of money in the near future, if the federal government would pay its loan back. It was never a loan authorized by the people, it was all out theft! There was 11 trillion given out in bail out money according to CNN, thats nuts, given by a government thats nuts! There are only 308 million U.S. citizens. one million millions is equal to one trillion. 11 trillion is 11 milliom millioms. 308 u.s. citizen would be millionares if the sick government would have given this bail out money to the people instead of steeling it, or giving it to the stock market, banks, and big coporations. We could buy what we wanted and got rid of the crooked politations, such as the malono, according to websters dictionary, Oboma.

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