nber recession probability

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For example, in the December 2017 FOMC meeting some … A similar relationship applies to the quarterly change in profits and investment. I enhance the simple model with two variables that should have predictive power for recessions.With the eagerness of alchemists looking for the universal elixir, business economists have forever been looking for economic or financial variables that can predict future economic activity. While the post-recession first estimates are revised up later, there is no impact on recession probabilities, as the other components of model 3 are already pulling the probability down to zero. It is this second component that has predictive power for future economic activity, not the first. The methodology is nothing more than a mechanism that puts investors’ anxiety and corporate profitability on a 0–1 scale. Last Update:

Note that the dashed red line and the blue line overlap perfectly at the end of the sample because the most recent data have not been revised yet. The dataset spans the months between January 1973 and March 2016, matching the availability of the credit spread data. Although the 12-month-ahead recession probabilities estimated using only the term spread have not exceeded 30 percent since the financial crisis, the estimates using credit spreads and corporate profits tell a different story.

However, the explanatory power of the credit spread comes from its EBP component, not the ED component.This being said, the credit spread is afflicted by the same concerns that affect the term spread. For example, in the December 2017 FOMC meeting some participants "expressed concern that a possible future inversion of the yield curve, with short-term yields rising above those on longer-term Treasury securities, could portend an economic slowdown, noting that inversions have preceded recessions over the past several decades," whereas "a couple of other participants viewed the flattening of the yield curve as an expected consequence of increases in the Committee’s target range for the federal funds rate, and judged that a yield curve inversion under such circumstances would not necessarily foreshadow or cause an economic downturn. It captures how much extra yield a borrower with constant default risk needs to pay to convince an investor to hold her bond at that point in time. However, the specific information considered by the public to be revealed is not clearly understood. Gilchrist and Zakrajšek call this measure of sentiment the excess bond premium (EBP). For example, a drop in demand may hurt profits, but production and investment would continue for some time to run down raw-material inventories or to complete investment projects that are in the final stages of implementation. Thus, the consideration of the decline in corporate profits in this period worsened the recession probability by 8 percentage points. I choose this date in order to include at least four recessions in my estimation. Furthermore, in areas like Europe, where the central bank is buying the investment-grade corporate bonds, the yields and spreads may no longer reflect market sentiment toward credit risk but expectations about central bank behavior.Given concerns over the stability of the predictive power of the term and credit spreads, I turn my attention to other financial measures that lack the forward-looking nature of the financial market data but should still have predictive power for future economic activity.The measure I propose is the inflation-adjusted quarterly change in pre-tax corporate profits.Using quarterly data since 1970, figures 2a and 2b show the three data series, but to improve the exposition of the relationship, I plot year-over-year changes rather than quarterly changes.

Figure 1: Estimated probability of recession within 12 months up to indicated date (blue), and in indicated month (red). Thus, the current two-year yield reflects the current one-year yield and the expected one-year yield one year from now.Admittedly, long-maturity yields reflect more than just future short-maturity yields, but this limited description is sufficient for our purposes.

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