Thursday, May 29, 2008

Confidence in estimate for probability of recession

Now that my move to New York City is beginning to wind down, I can refocus on some thoughts that have been percolating in the background. Some people insist that the U.S. economy is already in a recession, but my reading of the data does not concur. I will stick to my recent forecast that there is a 65% chance of the U.S. economy falling into recession in the coming months, but I would like to put some confidence intervals around that forecast. 65% is my "90% confidence interval" forecast, which means that I have a very high level of confidence that my forecast is correct. Traditionally, one provides 90% and 50% confidence intervals. I haven't quantified it before, but my 50% confidence interval is that there is a 35% chance of a recession in the coming months. That 35% chance is my core belief, but I do recognize that there is a huge amount of uncertainty.

More simply, I will say that there is a 35% to 65% chance that the U.S. economy will fall into a recession in the coming months and I lean towards 35%.

The recent economic data has been fairly flat and mixed, but still not "falling off a clifff" as one would expect if the economy had entered a recession back in Novemeber or December or January as some have insisted.

As of Tuesday, May 27, 2008, Reuters quotes Greenspan as saying:

I still believe there is a greater than 50 percent probability of recession. (But) that probability has receded a little and I think the probability of a severe recession has come down markedly.

Actually, the original source is the Financial Times article entitled "Greenspan warns of 'greater than 50% probability' of US recession." FT informs us than Greenspan is actually "puzzled" by the reletive strength of the economy:

He admitted he was puzzled by recent economic data that suggest the economy stopped deteriorating around March. "A recession is characterised by significant discontinuities in the data," he said. "It started off that way - there was a period of sharp discontinuity from December to March. But then it stopped."

Mr Greenspan believes there is a "tug of war" taking place in the economy, with financial sector stress pulling one way and strong corporate liquidity pulling the other. Corporate liquidity is being eroded, but only gradually.

"No one knows how this tug of war will end - specifically, whether the financial crisis will end before it drags down the real economy."

-- Jack Krupansky


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