Soft-landing, or no soft-landing, that is the question
|Summary
We developed a new framework that predicts the probability of stagflation, soft-landing and recession as well as the six-months-out probability of a policy pivot and the fed funds rate up to four FOMC meetings out. In a five-part series of reports, which we collate in this compendium, we detail our methodology and share how our framework can help decision makers quantify potential risks to the economic outlook.
In all, we believe our proposed new framework would help decision makers move away from the traditional approach of just forecasting recession probability and/or GDP growth rates for the near future. In the post-1950 era, our framework effectively predicted periods of soft-landing, stagflation and recession using a threshold of 33%. While the frameworks' prediction of a recession occurring in recent years did not match with a recession occurring in the economy as of June 2024, the framework accurately predicted the stagflation episode in 2021. Essentially, concentrating on more than one risk would increase the chances of predicting potential risks to the near-term economic outlook, providing an effective tool for analysts.
Additionally, our framework accurately predicted episodes of policy pivots in the post-1990 era using a threshold of 35%. In our view, accurately predicting periods of monetary policy pivots is vital, as a rate cut that comes too soon or too late would be harmful to the economy and damage the FOMC's reputation. Given the historical accuracy of our framework, we believe it can provide useful insights for decision makers, as it can be updated in real time to gauge the likely duration of the upcoming easing cycle. Our framework also predicted the turning points in the fed funds rate, at times more accurately than the Blue Chip consensus and the FOMC'S SEP.
In conclusion, using our framework to predict potential risks to the economic outlook and utilizing those probabilities to forecast policy pivots as well as the pace of adjustments to the policy stance would help decision makers to design effective policies.
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