Every recession is different, born of unique conditions that conspire to push an expanding economy into contraction. That’s certainly true for the deep decline in output that’s widely expected from the coronavirus fallout. As recessions go in the modern era, the one that’s arrived is a one-of-a-kind gut punch that few, if any economists expected as a recently as a month ago. The macro devastation will reorder recession-risk modeling and, in time, spawn new econometric tools. In fact, the change has already started with an early entrant to the new world order via the New York Federal Reserve, which this week announced a new index for monitoring the US economy in “real time.”
The inspiration for the bank’s effort: the sudden onset of recession, which has effectively blindsided many existing business-cycle indexes. As CapitalSpectator.com noted earlier in March, “Thanks to the lag in economic data, which can arrive as long as two to three months after the fact, formerly robust methodologies for tracking the US macro trend have become hopelessly out of date in recent weeks.”
In an attempt to address this shortcoming, the New York Fed developed the Weekly Economic Index (WEI) “to measure real economic activity at a weekly frequency.” The goal, the bank explains, is focusing on a particular challenge that arose in the current economic climate, namely: “When the economy hits sudden headwinds, like the COVID-19 pandemic, conditions can evolve rapidly.”
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WEI is a step in the right direction, although it’s not exactly a complete solution—or even a radical departure from a some existing business cycle benchmarks. For example, the Philly Fed has long published its ADS Index, which is also “designed to track real business conditions at high observation frequency.” Although ADS was a bit slow to react to the abrupt decline in economic activity, the index caught up with reality gradually, then suddenly in its March 27 update (based on data for conditions through March 21). The critical data input that’s triggered the huge drop in ADS: the massive increase in weekly jobless claims for the week through March 21. On the other side of this release, ADS fell off a cliff.
A similar descent has been picked up in WEI as of March 21 (jobless claims are also an input for WEI).
By contrast, monthly business cycle indicators remain woefully out of date. Take the Chicago Fed National Activity Index (CFNAI), for example: the latest update is for February, which reflects moderate growth. In the past, this measure of economic conditions has been highly valuable for tracking the macro trend. In the previous two recessions, the 3-month average of CFNAI delivered relatively early and reliable warnings. But this time events moved too quickly, leaving the index in the unfamiliar role of playing catch-up with reality. Presumably, the upcoming March report for the index will reflect the darkness that’s descended over the economy.
Normally, month-to-month changes in economic conditions unfold gradually. That was true even in the 2008-2009 recession. The current recession, by contrast, is an event of a radically different magnitude and speed and so the difference between the US economic profile for February vs. March is dramatic.
WEI is a step in the right direction for addressing (partially) the lag in monthly benchmarks. Even better, WEI uses a different data set and methodology vs. ADS and so the two metrics are complimentary to a degree.
Accordingly, I’ll be adding WEI to the mix in the weekly updates to The US Business Cycle Risk Report, which monitors and analyzes several business-cycle indexes for a close read on how recession risk is evolving.
Meantime, there’s a larger lesson here and it comes with a fresh dose of humility: the future always arrives with some degree of surprise and uncertainty. In the current situation, those factors crashed the party in record time with maximum blowback.
Human nature being what it is, we’re always fighting the last war, using tools and techniques that lean heavily on trying to anticipate the timing of the next crisis by looking to the previous one. That’s a tough challenge in the best of circumstances, and the rear-view mirror turned out to be mostly worthless in 2020. Perhaps WEI and other business-cycle analytics to come will soften the surprise factor the next time, if only slightly.
The New York Fed researchers who developed WEI are optimistic. “Our index is also quite robust to changes in the way it is constructed,” they write.
In normal times, familiar macroeconomic aggregates provide accurate descriptions of economic conditions with a modest delay. But, in a tumultuous setting, when conditions evolve rapidly from day to day and week to week, less familiar sources of data can provide an informative signal of the state of the economy. The WEI provides a parsimonious summary of that signal.
It sounds promising… and familiar. Ultimately, there’s only one test that matters: the next time the economy takes a hit, when the recession will render its judgment anew on the efficacy (or lack thereof) of metrics new and old. Meanwhile, humility is in order.
As Mike Tyson’s famously remarked: “Everyone has a plan until they get punched in the mouth.”
On a more practical level, economist Scott Sumner a few years ago advised that “people need to stop predicting recessions, because recessions are unforecastable.”
Agreed, which means that the next best thing is tracking how the risk evolves in real time. That’s still a valuable effort, most of the time. Until you get punched in the mouth with an unprecedented and rapid fall from grace.
How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report