Michael Dueker is a senior portfolio strategist at Russell Investments and formerly was an assistant vice president in the Research Department at the Federal Reserve Bank of St. Louis. Michael is also a member of the Blue Chip forecasting panel. In early February 2008, Michael submitted a piece to Econbrowser that correctly predicted the onset of the current recession, using a model-based forecast. We are pleased that that he is now presenting forecasts from the same Qual VAR model concerning the recession’s trough date and the magnitude of a jobless recovery to follow, subject to the disclaimer that the content is the responsibility of the author and does not represent official positions of Russell Investments and does not constitute investment advice.
Nevertheless, one could argue that the U.S. economy was experiencing a run-of-the-mill recession until the failure of Lehman Brothers, with the business cycle index bouncing around -0.5. After that shock, financial market conditions sent the economy sharply downward. As for a snap-back after the end of the formal recession, the projected path of the business cycle index is not as vertical as one might hope between zero and one in the second half of 2010. In fact, the cumulative area below +0.5 in the current downturn between August 2007 and January 2011 is quite large. Again this event calls into question the permanence of the Great Moderation in the U.S. economy after 1984.
Given that the past two recessions have been followed by jobless recoveries, where employment continues to fall and remain sluggish well after the end of the formal NBER recession, it is interesting to look at the Qual VAR’s forecasts of employment growth. The second figure shows that the forecast is for a jobless recovery to follow the NBER recession again, with payroll employment declining until March 2010 and not returning to trend growth until July 2010.
The most similar recession to the current one is 1973-75 when the unemployment rate increased about 4-1/2 percentage points in about a year and a half. In the double-dip recession in the early 1980s, the unemployment rate increased by 5 percentage points but this increase took 3-1/2 years. The stock market decline this year also resembles the death by a thousand cuts in 1974, when the U.S. stock market declined by about 30 percent without hitting a particular crash point.
A few details about the model: Here I have focused on a monthly version of the business cycle model that uses nonfarm payroll employment as the measure of economic activity. In addition, the model uses data on core CPI inflation, the spread between the interest rate on one-month commercial paper rate and Treasury bills, the rate spread between corporate and Treasury bonds and the slope of the yield curve. These quality spreads among interest rates are particularly important in the current context where the failure of the investment bank Lehman Brothers led to a severe contraction of lending in financial markets. For example, issuance of three-month commercial paper essentially ceased.
Originally published at Econbrowser and reproduced here with the author’s permission.