Do Economic Expansions die of old age?

Following Janet Yellen’s remark “I think it’s a myth that expansions die of old age” during the press conference on December 16, 2015, the Federal Reserve Bank of San Francisco (FRBSF) recently devoted its Economic Letter to that question. While market participants often attach rising recession probabilities to the duration of the cycle, records since World War II do not support the view that the probability of recession increases with the length of the recovery. Hence a long recovery, such as the current US expansion, appears no more likely to end than a short one.

Using survival analysis (a branch of statistics that is widely applied to human mortality rates in life insurance calculations), the FRBSF finds that a 50-month-old expansion has a 2% chance of ending the next month or, if this probability is cumulated over the next 12 months, the expansion has about a 23% chance of ending the year after. Interestingly, the same statistical technique yields very different results when applied to pre-WWII US expansions from 1854 to 1938.

Financial markets have reacted vigorously to the early-year weaker macro news flow. Beyond mounting fears of a marked downturn due to the late-cycle stage of the US economy, we have also identified limited ammunition in central bank toolboxes for preventing economies from falling into recession. To some extent, the purge of the 2008 shock is still ongoing. Eight years later, this is significantly limiting the countercyclical abilities of monetary and fiscal policies.

In a nutshell, empirical evidence indicates that expansions during the past 70 years have not become progressively more fragile with age. In this context, the better-than-expected GDP data published last week for Australia serve as a reminder that this economy is currently enjoying 24 consecutive recession-free years. The current slowdown in the US might just be part of the normal ups and downs. If the economy gets hit by shocks, it could be put into recession.