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For what is considered to be a lagging indicator of the economy, the unemployment rate provides surprisingly good signals for the beginnings and ends of recessions. We have developed a model that uses unemployment figures to produce these signals and to determine the probability of when a recession may start.

The current recession call from the Economic Cycle Research Institute (ECRI) is now more than six months old. Our model based on the unemployment rate which is presented here does not support ECRI’s call; it also tells us that a recession will not happen anytime soon.

The unemployment rate indicator

Monthly unemployment data is listed at FRED from 1948 onwards, a dataset that spans 11 recessions and covers a much longer period than the historical data for most other indicators – the Conference Board LEI, for example, or the ECRI Weekly Leading Index – whose performance one can only evaluate for the last seven recessions.

The unemployment rate (UER) over time is shown in Figure 1. It is depicted by the blue and red graphs, which are the short exponential moving average (EMA) and long EMA of the unemployment rate, respectively. (Appendix 1, for those who are interested, is a description of EMA.) The gray vertical bar graphs represent the 11 recessions during the time span the data cover.

Unemployment Rate and Recessions

It is apparent from Figure 1 that the blue graph, the short EMA of the UER forms a trough prior to the beginning of each recession.

Figures 2.1 and 2.2 incorporate the information depicted in Figure 1 and also show:

  1. The smoothed eight-month annualized growth rate of the unemployment rate, calculated from its 15-week moving average, which we refer to as “UERg.” That’s the green graph.  (Appendix 2 describes how to calculate UERg.)
  2. The time periods when the basic unemployment rate and/or UERg signaled recession, which are the gold-shaded parts of the graph.
  3. The dates of ECRI’s four recession calls of 1990, 2001, 2008 and 2011. These are the vertical purple lines in figure 2.2.

Unemployment Rate and Recessions
Unemployment Rate and Recessions

One can see from Figures 2.1 and 2.2 that the UERg, in green, has a well defined peak near the end of every recession, when the slope of the growth rate of the UER abruptly changes from positive (rising) to negative (declining).

It is similarly evident that the ECRI’s recession calls in 1990, 2001 and 2008 always coincided with a trough where the short EMA of the unemployment rate rose above its long EMA; UERg was always positive at those times as well.

This was not the case at the end of September 2011, however, when ECRI issued its most recent recession call. Then the unemployment rate had just formed a peak and the short EMA was below the long EMA of the unemployment rate, all completely atypical of when past recessions occurred. (Appendix 3 has the dates of ECRI’s recession calls and the corresponding recession signals from the unemployment rate.)