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A FACTIVA SEARCH REVEALS A RECENT RISE in the use of the phrase "double dip"—a relapse into recession—in media stories on the economy. So it's reassuring that a systematic look at lead-ups into past recessions puts the six-month probability of a double dip at approximately zero.
This nondismal finding comes from a model developed by dismal scientists at Credit Suisse. The model incorporates eight separate indicators that help signal recession: "real" factors, including employment, housing permits and consumer expectations; and financial factors, including the stock market and the interest rate on federal funds.
"Since recessions are important events," notes Credit Suisse's chief economist, Neal Soss, "a model that failed to signal one would be judged poorly." He adds, however, that "precisely because recessions are important events, we want to avoid 'crying wolf' by falsely predicting recessions when they don't occur."
On the positive side, the model has scored impressively. Before all seven of the past seven recessions, it began to flash "red," signaling a better than 50% probability of recession within the following six months. Actual lead times ran between four and seven months. For example, before the Great Recession of 2008-09, the red flash began in August '07, five months before the recession started. The 1981-82 recession, which struck just 13 months after the 1980 recession ended, was the one true double dip. The '81-82 second dip was first anticipated by the model six months before it started.
Regarding "false positives," the model cried wolf only once: for a three-month period in 1984, coinciding with the Continental Illinois banking crisis. But for a model tested monthly over more than 40 years—beginning with years leading up to the 1970 recession—a single three-month lapse is also impressive.
By contrast, consider the false positives that mar the record of the money- supply measures, none of which are included in the Credit Suisse model. The broadest money measure, known as M3, has been especially popular of late, no doubt in part because the Federal Reserve discontinued tracking it in 2006, arousing suspicion of a coverup.
According to independent updates, however, M3 has definitely has been running weak and even negative when adjusted for inflation. But might it be crying wolf? If so, that would be a repeat of its false-positive streak from 1991 through early 1995. Every month through that period of more than four years, inflation-adjusted M3 ran negative compared with the same month a year earlier, prompting fears of an imminent double dip. We now know that the expansion that began in 1991 continued into 2001.
The zero-probability reading on the six-month risk of recession by the Credit Suisse model indicates the money-supply measures are still crying wolf. But given the potential volatility of some of the model's indicators, its probability reading can change fairly quickly. For example, its financial indicators include not only the stock market (measured as the six-month percentage change in the Standard & Poor's 500 index), but the spread between the three-month London interbank offered rate, or Libor, and the three-month Treasury rate—a measure of private-sector credit risk, subject to sudden shifts. Also potentially volatile is the ratio of the price of energy in the consumer-price index to the overall CPI, and new unemployment-insurance claims, measured on a year-over-year basis. Any change in the Credit Suisse model will be reported in this column.
Email: gepstein@barrons.com
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