Guest Contribution: Model update and disagreement among recession models

Today we are fortunate to be able to present a guest contribution written by Rashad Ahmed (Office of the Comptroller of the Currency, US Treasury). The views presented are solely those of the author, and do not necessarily represent the views of the US Treasury, or any other organizations the author is affiliated with.

In light of recent debates over the “missing recession” despite a deep and prolonged US yield curve inversion, we decided to update the recession probability model proposed in Ahmed and Chinn (2022) that takes into account the most recent data on US and foreign yield curves along with other financial market variables.


Using data available as of Aug 10, 2023, the probit model assigns probability of 85% to a recession occurring within the next 12 months. Based on the estimation period from 1979-2021, a probability of 85% has a false-positive rate of 0.86% and a true-positive rate of 42.5%. Recession probabilities rose over the last six months from 68.1% predicted in December 2022. Some key drivers behind the recession probability forecast changed since the December projection. For one, the US and foreign term spread are both deeper in inverted territory, driving recession probabilities higher. But unlike December 2022 when trailing 3-month stock returns were negative and stock volatility was high, as of August, trailing 3-month stock returns turned positive and stock volatility fell substantially. Such equity market relief, holding all else fixed, reduces the probability of a recession. Oil prices increased over the last 3 months, marginally contributing to the increase in recession probability since December.

Contrasting our projection from December 2022, the GDP-weighted foreign yield curve is now inverted, as three of the four foreign term spreads turned negative alongside the US term spread: Germany, United Kingdom, and Canada. Just Japan’s term spread remains positive, although it’s worth noting that Bank of Japan’s yield curve control policies may be a factor here. As of August, the US near-term spread is also inverted (measured as the 2-year yield minus the 3-month yield).

It’s important to note that the model above only considers financial market variables when forming a recession probability. And while financial market-based recession probabilities may have risen, some economists, investors and policy analysts believe that the U.S. may be on the path to avoiding a recession. For example, Goldman Sachs chief economist Jan Hatzius recently reduced his recession probability to just 20%. So clearly, there is a high degree of disagreement between competing models on whether a recession will occur within the next year.

A key reason for such disagreement lies in that some financial indicators like yield curves are flashing red but other measures, particularly measures of real economic activity, remain robust. The rate of unemployment remains low at 3.5%, household balance sheets remain reasonably healthy, and consumers are still spending. In fact, heavy truck sales, a highly cyclical economic indicator, are at all-time-highs. Biden’s economic plan also appears to be taking shape in the form of a massive boom in non-residential construction investment – an indicator that otherwise declines during recessions.

That said, some signs of softening are starting to emerge. US imports are declining, driven by weaker demand for foreign goods (as opposed to foreign services). While unemployment remains low, job openings are vanishing quickly, especially in cyclical sectors like manufacturing. And the quantity of commercial and industrial loans extended by commercial banks is contracting.


So long as economic and financial indicators remain in disagreement, the only thing that is certain about future recession risk is the uncertainty around it.

This post written by Rashad Ahmed.

3 thoughts on “Guest Contribution: Model update and disagreement among recession models

  1. Ivan

    It is my understanding that the yield curve predictor of recessions has had an impressive track record in the US but not so much in the rest of the world. I do prefer models like this that takes a number of parameters into account. The biggest problem is that you don’t have enough datapoints to build the model on one set of data then test it on another independent set. That gets into the dilemma that they, by design, are perfect of predicting the past, but untested when it comes to predicting the future.

    1. New Deal democrat

      You are correct – for several reasons. One is that a number of recessions occurred between 1932 and 1960 with no yield curve inversion. A second is, as you point out, the infrequency of data points. Suppose we omnisciently knew that a model was right 5 out of 6 times. But this happens to be the 6th time. It’s discredited until the next time it’s right, maybe in 10 years. Finally, there is the “paradox of forecasting,” which is that the more peo;ple follow a model, the more their behavior is changed compared with iterations the model is based on. Ultimately instead of forecasting future behavior, it nowcasts behavior right now. Yuval Noah Harari calls this “2nd order chaos.” Or, when you observe the hoomans, the hoomans always observe back.

  2. pgl

    Krugman’s latest:

    Why Is China’s Economy Stumbling?

    Two years ago China was riding high. Decades of miraculous growth had transformed a desperately poor nation into an economic superpower, with a gross domestic product that by some measures was larger than America’s. China’s aggressive response to Covid was widely praised; its Belt and Road Initiative, a huge program of infrastructure investments around the world, was clearly a bid for global influence, maybe even supremacy.
    But now China is stumbling. Its “zero Covid” policy of locking cities down at the first indication of an outbreak proved untenable, but abandoning the policy hasn’t produced the expected economic surge. In fact, China is now experiencing deflation, inspiring comparisons with Japan’s slowdown in the 1990s (although Japan has actually done much better than legend has it).
    What has gone wrong? Can China reverse its slide? And how should the rest of the world, the U.S. in particular, respond?
    Some analysts attribute China’s stumble to policies of its current leadership. An influential recent article by Adam Posen, president of the Peterson Institute for International Economics, suggests that China is suffering from “economic long Covid,” a decline in private-sector confidence brought on by arbitrary government intervention, which began before the pandemic but has intensified since.
    But while the actions of Xi Jinping, China’s president, have indeed been erratic, I’m in the camp of economists like Michael Pettis of the Carnegie Endowment who see the country’s problems as more systemic.
    The basic point is that China, in various ways, suppresses private consumption, leaving the country with huge savings that need to be invested somehow. This wasn’t too hard 15 or 20 years ago, when ?g=17Igk” rel=”noopener noreferrer” target=”_blank”>Chinese G.D.P. could grow as much as 10 percent a year largely by catching up with Western technology: A rapidly growing economy can make good use of huge amounts of capital. But as China has grown richer, the scope for rapid productivity gains has narrowed, while the working-age population has stopped increasing and has begun to decline.
    Inevitably, then, growth has slowed. The International Monetary Fund believes that over the medium term China can expect a growth rate of less than 4 percent. That’s not bad — it’s something like twice the growth most observers expect for the United States. But China is still trying to invest more than 40 percent of G.D.P., which just isn’t possible given falling growth.
    This looming issue has been obvious for a decade or more, but China has been able to mask it largely by creating an immensely bloated real estate sector. This strategy, though, was unsustainable. Xi’s fumbles may have advanced the day of reckoning, but absent fundamental reform, China’s current predicament was only a matter of time.
    So is China down and out? Is Posen right in asserting that this is “the end of China’s economic miracle”?
    I wouldn’t count on it. As Adam Smith once remarked, “There is a great deal of ruin in a nation.” China is already a superpower, and its current stumbles aren’t likely to end that status. Furthermore, while China’s government has been weirdly resistant to reforms that might make its growth sustainable, we can’t assume that this resistance will continue indefinitely.
    And what do China’s problems mean for the United States? The Biden administration has taken a very hard line on China — much harder in practice than Donald Trump, who talked tough but mostly flailed around ineffectually. The U.S. government is now promoting semiconductor production to reduce dependence on China, trying to block exports of advanced silicon chips and, most recently, banning some high-tech investments in China.
    Have these actions become unnecessary now that China’s path to global dominance seems to be disappearing?
    No. You don’t have to be a xenophobe to be worried about the possible future actions of a superpower whose leadership seems to be growing more autocratic and more erratic with each passing year. Trying to reduce that superpower’s ability to do harm makes sense, even if it makes many people nervous. And the possibility that China may not be as much of a superpower as many expected doesn’t change that calculation.
    If anything, China’s problems may reinforce the case for precautionary action. China’s rulers have long relied on economic achievement to give them legitimacy. Now they’re facing trouble on the home front, most immediately in the form of rapidly rising youth unemployment. How will they respond?
    Ideally, as I said, they’ll push through long-needed reforms that put more income in the hands of families, so that rising consumption can take the place of unsustainable investment. But you don’t have to study much history to be aware that autocratic regimes sometimes respond to domestic difficulties by trying to distract the population with foreign adventurism.
    I’m not saying that will happen. But realistically, China’s domestic problems make it more, not less, of a danger to global security.

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