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The economic stall concept is valid in many countries [ClearOnMoney]
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The economic stall concept is valid in many countries

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Commentary

The economic stall concept is valid in many countries

18 Mar 2013 by Jim Fickett.

There is evidence that if US growth drops below a certain level, the likelihood of a recession is increased – this is the so-called “stall” concept. A new study shows that the stall concept is valid across a large number of, but not all, economies. The new study helps to understand how best to interpret results from the original one.

I have reviewed before the work of Jeremy Nalewaik in developing the concept of an economic stall – this is the idea that weak economic growth, particularly as measured by Gross Domestic Income, increases the likelihood of a recession occurring within the next few quarters (On the value and limitations of the "stall speed" concept).

This month Wai-Yip Alex Ho and James Yetman at the Bank for International Settlements released a working paper entitled Do economies stall? The international evidence. Their work is not directly comparable to Nalewaik's, for several reasons: (1) Nalewaik concentrates on GDI, while Ho and Yetman concentrate on GDP, (2) Nalewaik includes a number of indicators in an integrated algorithm, while Ho and Yetman look only at GDP, and (3) Nalewaik checks the forecasting value using preliminary data available at the time, while Ho and Yetman look only at data as finally revised. Still, the results of Ho and Yetman do further illuminate what we have learned from Nalewaik.

The first interesting result from Ho and Yetman is that some version of the stall concept is probably valid for many economies, but that the precise definition of slow growth may matter quite a lot. They test several variant definitions – first, a stall may simply be growth below a threshold, or it may require that growth was, in the previous quarter, above the threshold, and newly fell below it. And second, the threshold may be fixed, or it may be defined relative to trend growth, defined as the average growth rate over the previous 10 years. They find the most significant results when the threshold varies with trend growth, and when growth must have newly dropped below the threshold. In this case, they test whether the stall concept can improve GDP forecasting one-, two-, three-, or four-quarters ahead, in each of 44 countries, and find that in 79% of cases forecasting is improved. Results from other definitions of stall were much less impressive. Although Nalewaik's studies are quite different, this suggests that the Nalewaik algorithm might be more accurate with a variable threshold that depends on trend growth.

Recall that Nalewaik's stall-detection algorithm uses not only GDI, but also interest rates, the unemployment rate, and building starts. The popular press simplified Nalewaik's observations to the idea that a low growth rate would likely mark a coming recession but, in fact, Nalewaik is careful to point out that one needs all four observations, and that GDI in isolation is a weak predictor. This point is underlined by a second interesting result from Ho and Yetman, who find that in some economies slow growth is more likely to be followed by a rebound than by a further fall. Somewhat counter-intuitively, in some countries both algorithms built on the stall concept, and algorithms built on the rebound concept, can give improved results over algorithms with neither concept – in this case the two classes of algorithms are picking up different features in the data. These results show the importance of including other indicators than can help differentiate between a temporary dip and generally deteriorating conditions.

All in all, the results of Ho and Yetman

  1. Confirm that some form of the stall concept is important in many economies, not just the US
  2. Suggest that further research may increase forecasting accuracy if variations in the precise definition of “slow growth” are tested
  3. Confirm that GDI should not be used in isolation, but that a number of indicators are necessary to suggest a stall