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Economic SYNOPSES short essays and reports on the economic issues of the day 2007 ■ Number 27 What Are the Chances? Kristie M. Engemann and Michael T. Owyang quick glance through newspapers and economics web employment, industrial production, and personal income less sites yields any number of assessments about the probatransfer payments (the sales data are released a month later). bility that the economy is in or will enter a recession. Their probability of recession has been around 1 percent since How are such probabilities calculated? Some are likely back-ofOctober 2005.3 the-envelope calculations; however, several academic researchers To compare the different recession probabilities, we plotted have devoted considerable time toward discerning recessions in the former series along with the quarterly averages of the latter as timely and accurate a fashion as possible. series, as well as the NBER turning points. As the chart shows, One such group of researchers is the National Bureau of the resulting probabilities from both statistical methods spike Economic Research (NBER) Business Cycle Dating Committee. around the time of the NBER’s recession dates. Because the data They report (with some delay) the months when the economy they use are similar, the Chauvet-Piger method more closely fits entered and left a recession and are seen by many as the final the NBER turning points. However, small disparities between the authority on the timing of business cycle turning points. The comresults of each method persist. It may be that only when these mittee defines a recession as “a significant decline in economic recession probabilities are very high—say, above 65 percent— activity spread across the economy, lasting more than a few can we have confidence in a model’s accuracy. ■ months.” Because gross domestic product (GDP) data are released 1 Business Cycle Dating Committee, NBER. “The NBER’s Business-Cycle Dating quarterly and subject to revisions, they also examine a variety of Procedure,” released October 21, 2003. monthly economic indicators. The five most heavily weighted 2 Chauvet, Marcelle and Hamilton, James D. “Dating Business Cycle Turning Points.” indicators are real GDP, real personal income less transfer payNBER Working Paper No. 11422, June 2005; and blog post by James Hamilton, ments, payroll employment, industrial production, and real sales July 27, 2007, www.econbrowser.com/archives/2007/07/recession_proba_2.html. of the manufacturing and wholesale-retail trade sectors.1 3 Chauvet, Marcelle and Piger, Jeremy. “A Comparison of the Real-Time Performance Econometricians attempt to assess whether the economy is of Business Cycle Dating Methods.” Journal of Business and Economic Statistics, forthcoming; and www.uoregon.edu/~jpiger/us_recession_probs.htm. in recession before the NBER releases its turning points. They construct models predicated on the notion that the economy has two unobservable distinct states— expansion and recession. For example, Marcelle Recession Probabilities Chauvet and James Hamilton use the most recent revisions of GDP, including the advance estimate Percent for the most recent quarter, to obtain an index that 100 NBER Recession reflects the likelihood that the previous quarter was 90 Chauvet-Hamilton in recession. According to their model, a recession 80 Chauvet-Piger begins when the index rises above 65 percent and 70 ends when it falls below 35 percent. After the 60 advance second-quarter GDP estimate was released 50 in July, the recession probability index for 2007:Q1 40 was 26.2 percent, up from 16.9 percent for 2006:Q4, 30 but still not at recession level.2 20 Using a similar method, Marcelle Chauvet and 10 Jeremy Piger construct a monthly recession proba0 bility series: They use the same main indicators as 1988:Q1 1990:Q1 1992:Q1 1994:Q1 1996:Q1 1998:Q1 2000:Q1 2002:Q1 2004:Q1 2006:Q1 the NBER, with the exception of real GDP, and SOURCE: James D. Hamilton, www.econbrowser.com; Jeremy Piger, www.uoregon.edu/~jpiger/us_recession_probs.htm. estimate each probability by using all available manufacturing and trade sales data along with A Views expressed do not necessarily reflect official positions of the Federal Reserve System. research.stlouisfed.org
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