There's a 'relatively low likelihood’ of a recession in the coming year, according to an analysis by economists at the Irish Fiscal Advisory Council.
The paper, by IFAC’s chief economist Eddie Casey and Niall Conroy, examines a range of factors and indicators that might be used to predict a recession.
A recession is defined as a rise in unemployment in order to get away from the distortions in how we measure economic activity here, caused by accounting for the activities of foreign-owned multinationals.
According to the paper, models used to forecast growth in the economy can place too much emphasis on recent growth ‘as a predictor of future growth.’ This can obscure ‘key developments’ that may point towards the beginning of a downturn.
The paper assembles a range of indicators and tests their ability to predict recent recessions in Ireland, including the Dot Com Bubble and the Financial Crisis.
It finds that news stories, google searches for relevant terms like ‘recession’, input prices and measures of external demand (how other economies are doing) had little or no relevance in predicting past recessions.
Similarly, the intentions of Purchasing Managers reported in a monthly series and the performance of the ISEQ stock market index, showed little correlation.
However, it did find that the movement in the spread, or difference, between long dated and short-term US government bonds and the so-called TED spread which measures the difference between the rate of return on three-month US Treasury bills and the London Inter Bank Offered Rate (LIBOR) were relevant.
In normal times, the rate on long-dated US bonds would normally be higher than shorter dated bonds as an investor would demand a bigger return to invest their money for longer. But when recession looms, investors will often value or need short-term gains more, causing the rate on short-term bonds to increase.
The same goes for the TED spread, which can indicate that as recession looms, banks charge more to loan out money...so the LIBOR rate goes up which can lead to the ‘liquidity squeeze’ which happened during the financial crisis when banks stopped lending to each other.
The other indicator which proved useful was a survey carried out regularly by the European Commission which measures what expectations businesses have around future employment.
The authors say that employment expectations in Ireland have ‘disimproved of late.’ They also note that the US Term Spread and TED spread also both ‘signal some concern about future activity.’ However, they conclude that the indicators have ‘not deteriorated substantially’ and this points to a ‘relatively low likelihood of a recession’ this year.
However, they also caution that the model doesn’t take into account geo-political risks, nor the impact of inflation.
