Back in August, we were amused when Bank of America's chief economist, Ethan Harris, cut his 2015 GDP forecast from 3.3% to 2.3% in the span of one year (i.e., he was off by 30%) and yet in its latest long-term forecast predicted that the US economy would grow at a steady terminal pace of 2% (down from 2.2% previously) indefinitely. In other words, he forecast no recession over the next decade.
This is what he said: "Obviously, there is considerable uncertainty in forecasting many years out, so these should be viewed as rough baseline numbers. For example, if history is our guide, at some point in the next decade the US will experience a recession, but predicting a recession far in advance is almost impossible. We plan to update this table on a regular basis."
Then we laughed some more when that "other" big bank, Goldman Sachs tried to estimate just what the "impossibly to calculate" odds of a recession are. Its answer: "10-15% over the next year."
But don't despair: in keeping with the economist tradition of being overly optimistic, Goldman's economists also said the following: "Using a dataset on developed market business cycles, we calculate that the unconditional odds that a six-year-old expansion will avoid recession for another four years—and mature into a 10-year-old expansion—are about 60%."
According to the National Bureau of Economic Research (NBER)—which serves at the semi-official arbiter of US business cycle dates—the average US expansion has lasted only about 3 1/4 years, and the longest expansion lasted 10 years (from 1991 to 2001).
In other words, after central banks injected some $13 trillion (and rising) in liquidity to prop up global stock markets, Goldman is more than 50% confident that the current "expansion" will become the longest expansion in history.
It was unclear how much of global debt - currently around 30% - central banks would have to own by 2019 in order to justify this forecast.
And here, for our readers' amusement, is the full note:
US Daily: Going the Distance
- The current economic expansion is now more than six years old, raising questions about its “life expectancy”. Fortunately, the historical record suggests the age of the expansion has little bearing on the risks of a downturn—i.e. recession odds are only loosely related to time.
- Using a dataset on developed market business cycles, we calculate that the unconditional odds that a six-year-old expansion will avoid recession for another four years—and mature into a 10-year-old expansion—are about 60%.
The economic recovery that began in July 2009 is now 76 months or 6 1/3 years old. According to the National Bureau of Economic Research (NBER)—which serves at the semi-official arbiter of US business cycle dates—the average US expansion has lasted only about 3 1/4 years, and the longest expansion lasted 10 years (from 1991 to 2001). With some late-cycle phenomena such as elevated credit spreads starting to appear, questions about the current expansion’s “life expectancy” have become increasingly common. While there are undoubtedly risks to the outlook, the historical record suggests the age of the expansion itself has little bearing on the near-term prospects of a downturn.
To measure the duration of typical economic expansions we collected annual data on real per capita GDP for developed countries from 1850-2014 (we spliced together data from the Angus Maddison Project, the IMF’s World Economic Outlook, and Global Financial Data, Inc.). We then classified any year with negative per capita GDP growth as a recession, and all other years as expansions. This methodology is different from the one used by the NBER, but it allows for a consistent approach for all countries. The final dataset includes 355 expansions across 14 economies.
Exhibit 1 plots this history of developed market expansions. Two main points stand out. First, the duration of expansions seems to have increased over time. Prior to 1950, the average expansion lasted about three years, with only a handful of expansions lasting 10 years or more. Since that time, expansions have averaged about eight years, and many more have survived past the decade mark (the US average since 1950 is a bit shorter, at around five years). Second, the distribution of expansion durations is “fat tailed”, with many short expansions but many lengthy ones as well. For example, about 30% of the expansions since 1950 have lasted only one or two years, but another 30% have lasted nine years or more. Most of the very long expansions (those lasting two decades or more) represent the post-war rebuilding efforts in Western Europe and Japan.
Based on these historical business cycles, we can calculate the probability that an expansion will continue given a certain starting point—in the same way that one can derive survival probabilities from an actuarial table. When an expansion is just starting out, the odds that it will last more than six years—i.e. beyond the life the current US expansion—are only about 45%, based on data since 1950. However, the “mortality rate” of business cycles is fairly steady from one year to the next, with only a slight tendency to increase over time (Exhibit 2, left panel). Therefore, conditional on an expansion reaching six years of age, the odds that it can continue are still reasonably good. Again using data since 1950, we calculate that the unconditional odds that a six-year-old expansion will avoid recession for another four years—and mature into a 10-year-old expansion—are about 60% (Exhibit 2, right panel).
It’s important to stress that these figures represent unconditional probabilities—the equivalent of life expectancies without regard to physical health. That being said, we see the historical record as mildly encouraging, and the message broadly aligns with our judgmental view—we would put the odds of recession over the next year at about 10-15%. Although there are clearly some risks to the US economy—especially from developments abroad—we do not expect the expansion to expire of old age.
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Yes "longer expansions" as Goldman adds, however what it forgot to note is how much more violently they tend to end, in a time when their duration has been artificially expanded with ever more aggressive central bank intervention around the globe.
What Goldman also forgot to add is that in the "conditional probability" of an expansion hitting 6 years only took three QEs, one Twist and 7 years of ZIRP. What will push it forward? Oh wait, it's the "bullish" rate hike.... oddly enough rate hikes were not that bullish to be considered as economic growth factors in 2009... or 2010... or 2011... or 2012... or 2013... or 2014... In fact, while the US is hiking as a "bullish sign", the ECB is planning to cut rates even more negative you know, because that too is "bullish."
That said, this being a Goldman forecast, we are confident readers realize that a looming recession is now the base case.