In the previous post, I gave some graphs plotting (effective demand - potential real GDP) against the UT index since 1967. Now I want to focus in on some of the dynamics of those graphs. Let's start by looking atdata from 4Q-2003 to 1Q-2008. It was the period of an expansion before the crisis.
The plot is the blue line. The orange dashed line is the trendline of the plot. The y-intercept is pointing toward a value of $145 billion when the UT index hits zero. The calculated unemployment rate at the y-intercept would be 4.6%. However, the unemployment rate bottomed out at 4.4% before the plot could reach a UT index of 0%. The UT index was only 0.7%.
The hypothesis now is that the trendline points to the lower limit of the unemployment rate in an expansion. I checked the other past expansions and this hypothesis was consistent with all of them. Even when the UT index went to -2%, the ultimate low of the unemployment rate equaled the calculated unemployment from the y-intercept where the UT index = 0%. Thus, the y-intercept determines the bottom limit of the unemployment rate in a particular business cycle.
Now let's apply the hypothesis to current data.
The current data is pointing straight toward a lower limit of 6.9% for the unemployment rate. This agrees with a previous analysis I made. Now, according to the above hypothesis, unemployment will have a lower limit around 6.9% to mark the end of the expansion, irregardless of whether the UT index is positive or negative. In other words, if we reach 6.9% unemployment and the UT index reads -2.3%, we have hit the end of the expansion. Also, if we reach 6.9% unemployment and the Ut index reads +1.5%, again we have hit the end of the expansion. Therefore, 6.9% marks the end of the expansion anyway you look at it. (see math in preceding post on how to calculate the unemployment rate at the UT zero lower bound, where the UT index = 0%.
I have been targeting 7.0% in my prediction. and I will stand by that. But there is something very promising about this graph. We might be able to pinpoint the end of an expansion using the unemployment rate. If we could do that, this takes economic analysis to a new level.
