Calling Recessions in Real
Time
James D. Hamilton
Dept of Econ, UCSD
I. Overview of some of the issues
II. Track record of alternative approaches
Date of recession
Announcement lag
peak
trough
peak
trough
Jan 1980
Jul 1980
5 months
12 months
Jul 1981
Nov 1982
6 months
8 months
Jul 1990
Mar 1991
9 months
21 months
Mar 2001
Nov 2001
8 months
28 months
Is our objective to:
• predict at t whether we will be in a
recession at t + j
or
• predict at t whether we were in a recession
at t - j
Theme: It’s very hard even to do (2) in real
time.
Why should it be hard?
(1) recessions result in part from forecast
errors
(a) Fed misjudges economy
(b) Firms misjudge markets
(2) economic relations change over time
June labor force participation rate
(women aged 35-44)
90
80
70
60
50
40
30
1945
1955
1965
1975
1985
1995
2005
June labor force participation rate
(men aged 45-54)
100
90
80
70
60
50
40
1945
1955
1965
1975
1985
1995
2005
Why should it be hard?
(1) recessions result in part from forecast
errors
(2) economic relations change over time
(3) data revisions
Source:
Leamer (2008)
Nonfarm payroll employment as reported on different dates
What is the definition of a recession?
Possible answers:
A. Ad-hoc qualitative summary of
observable data (e.g., 2 quarters of falling
real GDP)
B. It’s a recession if and only if the NBER
says so
C. A recession is an objective but
unobserved determinant of the data
I. Overview of some of the issues
II. Track record of alternative approaches
A. Predicting an ad-hoc event
Ray Fair (1993)
y 1t GDP growth in quarter t
St 
1 if y 1t 0 and y 1,t1 0
0 otherwise
y t c 1 y t1  p y tp 
t
model implies
Pr
S tj 1|y t , y t1 , . . . . 
Stock-Watson experimental
recession index (1988-1993)
y t 
Lc t ut
D
L
ut 
t
Lc t   t
8
S t 1 if c ts s0  B t
B t inferred to approximate NBER
In-sample: P(t|t)
In-sample: P(t+3|t)
In-sample: P(t+6|t)
Out-of-sample: P(t+6|t)
Out-of-sample: P(t+3|t)
Out-of-sample: P(t|t)
Recession began: July 1990
P(t|t) > 0.5 by Nov 1990
I. Overview of some of the issues
II. Track record of alternative approaches
A. Predicting an ad-hoc event
B. Predicting what the NBER is going to
say
Pr
S tj 1|y t F
y t ; 
Choose F
. and y t
Estimate 
Katayama (LSU, 2008)
Interest Rates
•
•
•
•
•
•
•
FF Federal Funds rate
3M 3-month Treasury Bill rate
5Y 5-year Treasury Bond rate
10Y 10-year Treasury Bond rate
AAA Moody's corporate bond yield
AA Moody's corporate bond yield
A Moody's corporate bond yield
Term Spreads
•
•
•
TS10YFF 10Y-FF Treasury term spread
TS10Y3M 10Y-3M Treasury term spread
TS10Y5Y 10Y-5Y Treasury term spread
Credit Spreads
•
•
•
CSAAA AAA - 10Y spread
CSAA AA - 10Y spread
CSA A - 10Y spread
Employment Data
•
•
•
•
•
•
EMP Δ log non-agricultural employment
CEMP Δ log civilian employment
UICLAIM Δ log unemployment claims
UNEMP Unemployment rate
UNEMPD Change in unemployment rate
HOURS Δ log manufacturing hours
Stock Price Indices
•
•
DJ30 3-mo Δ log Dow Jones 30 average
SP500 3-mo Δ log S&P 500 stock price
index
Monetary Aggregates
•
•
•
M0 Monetary base (log-differenced)
M1 (log-differenced)
M2 (log-differenced)
Other Macroeconomic Variables
•
•
•
•
•
•
•
•
•
CLI11 Δ log composite leading indicators
CPI, all urban, all items (log-differenced)
EXP Consumer expectation
EXPD Changes in consumer expectation
HOUSE Building permits (log-differenced)
VENDOR performance
INCOME Δ log personal income
IP Industrial production (log-differenced)
SALES Δ log Manufacturing & trade sales
Evaluated with 7 different choices for F(.) by
post-sample and leave-2-years-out crossvalidation
Conclusion:
Improvements from F(.) with positive skew and
excess kurtosis
Best variables:
• 10Y-3M treasury spread
• S&P500 3-month growth
• employment growth
Chauvet and Potter (2002, 2005)
Probit specification based on term spread
allowing for serial correlation and
structural breaks successfully predicted
2001 recession
Wright (2006)
• F(.) ~ Normal
• 10Y-30M treasury spread
• fed funds rate
• tries to predict an NBER recession any
time within next 12 months
Leamer (2008):
Choose thresholds for 6-month changes
so as to fit NBER dates
I. Overview of some of the issues
II. Track record of alternative approaches
A. Predicting an ad-hoc event
B. Predicting what the NBER is going to
say
C. Recognizing a shift in the observed
dynamics of economic variables
y t GDP growth for quarter t
St 
1 if recession at t
0 if not recession at t
y t  s t 
t
2

0, 
t  N
S t unobserved
Pr
S t j|S t1 ip ij
Density of expansions
0.15
0.1
 = 4.7
 = 3.5
0.05
0
-15
-12
-9
-6
-3
0
3
6
9
12
15
GDP growth
Density of recessions
 = -1.2
 = 3.5
0.15
0.1
0.05
0
-15
-12
-9
-6
-3
0
3
GDP growth
6
9
12
15
Density of mixture
0.12
0.1
0.08
0.06
0.04
0.02
0
expansion
recession
mixture
-15 -12
-9
-6
-3
0
3
6
9
12
15
Density of mixture
0.12
0.1
0.08
0.06
0.04
0.02
0
expansion
recession
mixture
-15 -12
-9
-6
-3
Pr(St  2 | yt ) 

0
3
6
9
12
Pr(St  2, yt )
f ( yt )
Pr(St  2, yt )
Pr(St  1, yt )  Pr(St  2, yt )
Pr(St  2, yt )  Pr(St  2)  f ( yt | St  2)
15
Density of mixture
0.12
0.1
0.08
0.06
0.04
0.02
0
-15
-12
-9
-6
-3
0
3
6
9
12
15
9
12
15
Probability of recession
1
0.8
0.6
0.4
0.2
0
-15
-12
-9
-6
-3
0
3
6
GDP growth in quarter t
Filter inference:
Pr
S t 1|y t , y t1 , . . . , y 1 
Smoothed inference:
Pr
S t 1|y T , y T1 , . . . , y 1 
Contributions to percent change in
real gross domestic product
6
5
GDP
4
Consumption
3
Nonresidential fixed investment
Residential fixed investment
2
Change in inventories
Exports
1
Imports
0
Government
-1
-2
2007:Q3
2007:Q4
2008:Q1
2008:Q2
Chauvet and Hamilton (2006), Chauvet and Piger (2008)
Ft  s t Ft1 t
y rt  r Ft v rt
v rt  r v r,t1 
rt
 ln sales
yt 
 ln pers income
 ln civ employ
 ln ind prod
Month
Probability of Recession
February 2008
15.4%
March 2008
16.0%
April 2008
15.6%
May 2008
15.3%
June 2008
14.0%
July 2008
13.0%
Source: Jeremy Piger, Sept. 29, 2008
Source: Jeremy Nalewaik
Source: Jeremy Nalewaik
Hamilton (2005)
y t unemployment rate
y t c s t 1 y t1 2 y t2 
t
1 if expansion
St 
2 if mild recession
3 if severe recession