Recession Predictions: Why Economic Indicators Often Fall Short

Forecasting recessions has proven challenging, with several indicators recently suggesting downturns that haven't materialized.

In 2022, the Conference Board’s Leading Economic Index and the inverted yield curve both signaled a recession, and the common definition of two consecutive quarters of negative GDP was met. More recently, the Sahm Rule, which tracks sudden increases in unemployment, also flashed a warning in early August. Despite these signals, many economists argue that the U.S. is not currently in a recession.

According to the creators of these indicators, the pandemic has made accurate predictions even harder. Campbell Harvey, who developed the inverted yield curve model, acknowledged that no indicator can be perfect due to the economy’s complexity. The National Bureau of Economic Research (NBER) defines a recession as a significant, widespread decline in economic activity lasting more than a few months, but it often declares recessions long after they begin.

This uncertainty fuels the interest in predicting future recessions. While accurate forecasts can be valuable for investors and policymakers, they are inherently imperfect. For instance, Claudia Sahm’s unemployment rule, which has recently raised concerns, may be flawed due to its inability to fully account for changes in the labor force, such as increases in immigration.

Even the historically reliable inverted yield curve has shown signs of a potential recession since November 2022, but the anticipated downturn has not yet occurred. Harvey suggests that the indicator’s accuracy might have prompted preemptive actions that could have averted the predicted recession, highlighting its limitations.

Overall, the unpredictable nature of economic indicators underscores their imperfections. As economist Steven Pearlstein noted, traditional data often misses underlying issues, such as financial bubbles. Jason Furman of Harvard compared predicting recessions to rolling dice: while we can understand probabilities, we can’t foresee outcomes with certainty.

In essence, while recession indicators can provide valuable insights, they are not foolproof and often fail to predict economic shifts with complete accuracy.