Most economists expected a recession in 2023. This prediction didn’t even come close—indeed 2023 was a boom year. I’ve already discussed one implication of that fact; economists are lousy at predicting the business cycle, and should not even try.
There’s another lesson to be derived from the 2023 non-recession; don’t put too much weight on statistical patterns that might look reliable at first glance. Readers of this blog know that I often push back on claims that the “yield curve” is an infallible indicator of turning points in the business cycle.
David Beckworth recently directed me to a tweet showing that the yield curve has now been inverted for 589 days. Forecasters often claim that a recession is inevitable within 12 months of a yield curve inversion. This is not the case:
I do believe that an inverted yield curve provides some useful information. It can be seen as an indicator that investors probably expect a slowdown in NGDP growth going forward. But it’s not perfect.
I did a recent post on “bad reasoning” regarding the lab leak hypothesis for Covid. Recession forecasting is another example of bad reasoning. Yield curve inversions tend to occur rather late in a business cycle. And America tends to have recessions roughly every 5 years, on average. Combining those two facts, it’s not surprising that recessions often occur within 12 months of a yield curve inversion. But not always.
Human beings are very good at noticing statistical patterns. We are always on the lookout for patterns that help us to better navigate through the world around us. And patterns are in fact often quite useful. Yield curve inversion is often an accurate precursor of recessions. But I also find that people become too overconfident with these patterns, assuming that just because a pattern has worked in the past, it will continue holding true.
The Fed is always trying to prevent recessions. If a truly infallible indicator of recessions were to be established, the Fed would react to that by adjusting monetary policy in such a way as to make the recession less likely. For this reason, it is unlikely that we will ever have a reliable technique for forecasting recessions.
PS. The yield curve did predict the Covid recession of 2020, but I suspect that this was just “dumb luck”.
READER COMMENTS
Thomas L Hutcheson
Jun 8 2024 at 12:11pm
The way to predict recessions/over-target inflation is to have a good model of what the Fed should be doing to avoid recession and observe whether it is in fact acting in accordance with that model.
spencer
Jun 9 2024 at 11:16am
Economic prognostications within a year are infallible.
Michael Sandifer
Jun 10 2024 at 2:30pm
Markets were never predicting a recession, so if one understood how to read the markets, there would have been no recession predictions.
Jerry Melsky
Jun 10 2024 at 5:32pm
I’m surprised at how the topic of ample reserves never seems to come up. I would have thought that ample reserves would have an effect on a whole lot of monetary dynamics including the prognostic powers of the inverted yeild curve (as weak and misunderstood as those powers might always have been.) I’m not intending this to be a critique of Dr. Sumner. The entire business/economics media seems to ignore the big shift in monetary regime that happened in 2008, it doesn’t seem to matter to them, central bank policy works exactly as it always has.
Grand Rapids Mike
Jun 11 2024 at 10:55pm
The whole thing of the inverted Yield curve was and is a forever talking oiunt on CNBC and such shows. I would like to know what the Economists who did not buy into this nonsense thinks about the business cycle now. Any real Economist, would know the excessive and never ending fed gov. spending was going to support the economy, unless the the Fed really clamped down on the M2, which it has not. Let’s hear what Milton Friedman has to say.
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