The NBER (National Bureau of Economic Research) has a Business Cycle Dating Committee that determines recessions. Many believe that their method uses 4 main indicators...
- Industrial production
- Employment
- Real personal income (excluding transfer payments)
- Real retail sales
You can see a mix of supply and demand. Industrial production and employment point to supply. Real personal income and real retail sales point to demand.
Be that as it may, I use a UT index, which has a zero lower bound, ZLB. Whenever the economy reaches the UT index ZLB, a recession follows within a period of time.
The UT index basically measures the difference between real GDP and effective demand. Think of real GDP as supply and effective demand as demand. What indicators are incorporated in the UT index?
- Capacity utilization
- Employment
- Labor share of income
- Real GDP or real GDI.
- Capacity utilization > Industrial production
- Employment > Employment
- Labor share of income > Real personal income
- Real GDP or real GDI > Real retail sales
The two lists are very similar in the areas they look at. Actually, the reports for capacity utilization and industrial production come out together. The match between real GDP and real retail sales is not as clear as the other 3. (note: Real GDI is known to be a better indicator of recessions than real GDP. This knowledge comes from Dwaine at recessionalert.com)
The UT index comes from the equation for Effective demand. All 4 variables express together in the equation. They are not read separately. The equation combines them and analyzes them for me. Does NBER have an equation for their variables? I don't know...
When I track the UT index with the start dates of recessions since 1967, there is one thing that stands out… and anybody interested in forecasting recessions should listen carefully.
The UT index bottomed out before every recession started.
Here is a graph from FRED showing this…
Every recession started only after the UT index had bottomed out. This makes perfect sense. The economy is still producing well when the UT index starts to show a little contraction. And the economy can oscillate near its bottom. But the UT index will show us clearly that the economy is ending its expansionary phase. The bottom of the UT index is the time to get prepared because a recession is looming at some point.
Have we reached the bottom of the UT index? No we haven’t… but watch carefully over the next 4 months. The UT index is going to move toward its zero lower bound. The UT index is at 2.82% as of 4Q-2012, but I forecast it will go below 2.0% in the 1st quarter of 2013. I also see that real GDP will be over $13.800 trillion for the 1st quarter of 2013. I base this on a rise in capacity utilization in the 1st quarter and on a projection of effective demand, which declines by around 0.40% after a sharp rise in effective labor share as we saw in the 4th quarter of 2012.
With these changes, the UT index would go to around 1.5% (on a quarterly basis). Is this low enough to signal a recession? Well, let’s put it this way… The UT index has never bottomed out above 1%. But we are getting close.
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