Many economists were expecting a recession in 2023. This prediction didn’t come close—2023 was definitely the best year. I have already discussed one consequence of that fact; economists shy away from predicting the business cycle, and shouldn’t even try.
There is another lesson to be learned from the recession of 2023; don’t put too much weight on statistical patterns that may look reliable at first glance. Readers of this blog know that I often discount claims that the “yield curve” is an infallible indicator of turning points in the business cycle.
David Beckworth he recently directed me to a tweet showing that the yield curve is now 589 days inverted. Forecasters often say that a recession is inevitable within 12 months of yield curve inflection. Not so:
I believe the inverted yield curve provides useful information. It can be seen as an indication that investors are likely to expect a slowdown in NGDP growth going forward. But it’s not perfect.
I did a recent post on “bad thinking” about the lab leak hypothesis of Covid. A recession forecast is another example of bad thinking. Yield curve inversions often occur late in the business cycle. And America tends to have a recession about every 5 years, on average. Combining those two facts, it’s no surprise that recessions often occur within 12 months of yield curve inversions. But not always.
Humans are very good at recognizing mathematical patterns. We are always looking for patterns that help us better navigate the world around us. And patterns are in fact often very useful. An inversion of the yield curve is often an accurate precursor to a recession. But I also find that people become overconfident in these patterns, thinking that because the pattern has worked in the past, it will continue to hold true.
The Fed is always trying to prevent a recession. If a truly infallible indicator of a recession were to develop, the Fed would respond by adjusting monetary policy in such a way as to make the recession less likely to subside. For this reason, it is unlikely that we will ever have a reliable way to predict recessions.
PS. The yield curve predicted a 2020 Covid recession, but I suspect this was “just luck”.