Trying to Call a Recession

No answer when it comes to predicting crises.

August 12, 2010

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red phoneThe financial crisis has spawned a new lexicon. It includes TBTF banks (“too big to fail), TARPs  to fit over TBTFs (Troubled Asset Relief Program), and a transition from the “Great Moderation” to the “Great Recession.” Someone’s providing a lot of makeshift shelters.

Which leads to another term from the new lexicon: hoocoodanode or who could have known?

Indeed, who could have known what countries were in trouble betwixt the cup of the Great Moderation and the sip of the Great Recession?

Andrew K. Rose, professor of international business at the Haas School of Business at the University of California, Berkeley, and Mark M. Spiegel, vice-president, economic research and data at the Federal Reserve Bank of San Francisco try their hand at it, in their article  “What do we know about the causes of the crisis?”

They survey the distant early warning literature, concluding: “It might seem like the problem faced by those constructing early warning systems lies in winnowing down the vast set of plausible causes of the crisis, rather than in finding ones that work.”

Too much chaff on the radar screen, one might argue.

Not that Rose and Spiegel have a better solution. Instead, they argue: “It has historically proven difficult to link crisis causes to their timing; it is easier to link the cross-country incidence of crises to their causes. Of course a successful early warning system must predict both the incidence and the timing of future crises, but one might as well to try to solve the easier problem first.”

So let’s settle for the retrospect. What does the easier solution tell us?

“The six most successful variables in understanding the Great Recession are:

  • the 2006 current account (expressed as a percentage of GDP);
  • the 2006 measure of credit market regulation estimated by the Heritage Foundation;
  • 2000-06 growth in bank credit (again as a percentage of GDP);
  • the country’s trade with the US as a fraction of its 2006 trade;
  • the 2003-06 growth in stock market capitalisation; and
  • the log of 2006 real GDP per capita.”

So far so good.

Except for this: “We take the model which best fits the Great Recession and ask how well it would have worked earlier. We examine two global downturns: the 1991 downturn associated with the Gulf War (for Americans) and German Unification (for Europeans), and the 2001 “dot.com” recession. Unfortunately, we find that even the best estimates gleaned from the Great Recession are not stable predictors of the incidence of global recessions at different periods of time.”

The authors conclude that you’re never in the same river twice. Let’s at least hope the waters are less muddy than they were before.

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