The Lazy Economist: The very spooky indicators of recession

Part three of a three-part series on the ups and downs of the economic cycle

Recessions can be predicted through a variety of hard-to-spot signs.
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In honour of Halloween, The Lazy Economist is closing its recession series with some very spooky signs that a recession might be looming in North America.

As explained in an earlier edition of this column, a recession occurs when the economy slows down. People spend less money, companies slow their production and lay off employees, and the economic mood is generally sombre.

It’s notoriously hard to predict when exactly the next recession will occur, but economists have figured out measures that may indicate when the economy is starting to slump. These indicators range from the sophisticated to the silly, and in this article, we’ll cover a few of them.

The king of all recession indicators, and the one you’ll probably hear about on the news, is the yield curve. Historically, it’s been eerily accurate at predicting recessions.

A yield curve is a curve on a graph that tracks the rate of return for different types of bonds. Bonds are vehicles for saving money, where you give a certain amount of money to the issuer of the bond for a certain amount of time. At the end of that time period, you get your money back with interest.

The rate of return is basically the profit you get on the investment. The length of time you agree to have your money in a bond is called the “maturity” of the bond.

In a good economy, bonds with longer maturities (e.g. five or 10 years) have higher rates of return, while bonds with shorter maturities have lower rates of return.

When a recession is looming, this relationship reverses. Shorter-term bonds have higher rates of return and longer-term bonds have lower ones. This is called an inverted yield curve. 

An inverted yield curve generally predicts a recession because investors are more uncertain about the future. Normally, longer-term bonds return more interest because longer-term investments tend to be riskier. However, if investors are uncertain about the future economic outlook, they’ll want to keep their money in shorter-term assets because they expect interest rates to get lower in the future as the economy worsens.

Another indicator is unemployment. As mentioned earlier, when consumers buy fewer goods and spend less money, companies lay people off. This one might be obvious, but a related and less-often discussed indicator is hours worked. Companies often cut employee hours before they start laying people off, so this can be a useful measure of an upcoming recession.

Cardboard sales are another surprising indicator. Since virtually everything is shipped to stores in carboard boxes, if demand for cardboard suddenly tanks, then that might mean people are buying less stuff and that a recession is on the way. The same is true for many other shipping-related businesses.

There is also the famous hemline index theory: the idea is that miniskirts come into style when the economy is good, and longer skirts appear more when the economy is doing badly.

No one really knows exactly why this is. The theory was introduced in the 1920s and is typically thought of as an urban legend. However, some researchers at Erasmus University found that the economy actually does predict hemline, but with about a three year lag. So today’s economy should predict skirt lengths in the early 2020s.

Furthermore, if this is true, the economy predicts what styles of skirts people want to wear, not the other way around.

Fashion trends don't change the trajectory of the economy overall, though, so don’t get too worried if you see a bunch of maxi skirts around campus.

Another unorthodox indicator is men’s underwear sales. This one was proposed by former US Federal Reserve Chair Alan Greenspan, who has a pretty good reputation in macroeconomics. Greenspan put forth that since men basically only buy new underwear when they need to, any dip in sales would indicate that people have very little money to spare.

While it might be impossible to predict the next recession, if you get bored of this year’s horror movie selection, try spooking yourself by reviewing some of these recession indicators.

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