Can a Recession Be Foretold?

Yes, there are a variety of tools and methodologies to help predict recessions, but they are not perfect. Forecasting efforts range from large-scale general equilibrium econometric models to new machine learning methods. These methods can yield a series of future growth rate forecasts. Econometric models can also indicate the probability that the economy is likely to register a turning point. In contrast, some diffusion indexes like the purchasing managers indexes and consumer and business sentiment indexes are compiled to take the pulse of market participants and their reflections about overall economic conditions. These types of indicators attempt to directly answer the question of whether the economy will be in recession (expanding or contracting) at a given time in the future. Other approaches rely on financial indicators such as interest rates on bonds and interest rate spreads that rapidly summarize a lot of information about economic conditions and are available in real time. 

In addition, indexes of leading indicators belong in the general category of diffusion indexes. The Conference Board Leading Economic Index® (LEI) is used as a barometer of future economic conditions and a forecasting tool. The LEI is a systematically aggregated, objective, and reliable forecasting tool. Importantly, it points to changing conditions in the economic cycle. While there are various ways to interpret the LEI in real time, a reliable rule of thumb looks at the duration, depth, and diffusion—the 3Ds—of a downward movement in the index. Duration refers to how long-lasting a decline in the index is, and depth denotes how large the decline is. Duration and depth are measured by the rate of change of the index over the last six months. Diffusion is a measure of how widespread the decline is (i.e., if the majority of the index components are deteriorating).

The 3Ds rule provides signals of impending recessions when two criteria are satisfied simultaneously: 1) a majority of the 10 LEI components are in contraction territory (black dotted line in the chart), and 2) the magnitude of the decline over six months is at least 4.0 percent annualized. If both criteria are met simultaneously (red dotted line), the LEI signals a recession. According to the figures published on September 22, 2022, the 3Ds rule confirmed a signal of an imminent recession in the US economy. 

For more information on the most recent iteration of The Conference Board Leading Economic Index®, please visit our website. 

For our most recent outlook, please see US economic forecast.