Wednesday, December 2, 2009

A better way to identify recessions

In an era of rampant conspiracy theories and mistrust of institutions, many have been sceptical of the National Bureau of Economic Research decision process with respect to identifying the start and end of recessions. Not only is the pronouncement on a significant lag, but some think the timing may have a political or some other bias.

To address this issue, James Hamilton from UC San Diego developed an index that uses the GDP data to "measure" the probability of the economy being in recession at a particular time. The strength of the approach is that it uses GDP trends (as opposed to just the latest number) over recent quarters to determine the probability. It's a mechanical approach that doesn't require judgement that is embedded in the NBER's decision process, therefore taking out any real or perceived bias. The measure is also much more current and does not require one to wait several quarters before confirming the beginning on the end to a recession.

Here is how the index compares to the NBER's pronouncements:

source: Atlanta Fed