Mark Perry had a nice post yesterday with an update of the Fed's model for predicting recessions and recoveries. The upward slope of the Treasury yield curve now says that the probability of recession this year is rapidly approaching zero: "the Fed's model shows a recession probability of only about 1% on average through the next 12 months, and below 1% by the end of the year."
This prompted me to update my own model, which also uses the slope of the yield curve, but which adds in the real Fed funds rate, since the latter is a good measure of just how tight or loose the Fed actually is. As this chart shows, the yield curve is always negatively sloped going into recessions and positively sloped coming out of recessions. That's because every recession in modern times has been preceded by a significant tightening of monetary policy, and a return to easy money has marked the end of every recession. So today it is clear that we have the essential monetary ingredients for a recovery. Indeed, given the rise in commodity prices and other signs of improvement that I've been noting for awhile, it seems pretty likely that the economy will be on the mend before mid-year, as I predicted at the end of last year.
Of course, when recessions end it is never immediately obvious, and it typically takes many months or even a year or more before the numbers confirm that the recession has ended. I recall how Bush Sr. lost his reelection bid in 1992 in part because of the widespread belief that the economy was hopelessly mired in recession; by the end of 1993, however, revised numbers came out which showed that the economy had actually enjoyed a decent recovery in 1992. Similarly, during the summer and fall of 2003 the mantra was that we were in a "jobless recovery," monetary policy was "pushing on a string," and deflation threatened the global economy. We later learned that the economy took off like a rocket starting in July of that year.