4 January 2010 – Chart of the Week
Chart of the Week: The Zarnowitz Rule in the Business Cycle
The “Zarnowitz Rule” states that deep recessions are followed by equally strong recoveries. The consensus begs to differ. Vigorously.
In the late 1930s, Victor Zarnowitz fled Poland ahead of the Nazis only to be put in the Gulag by the Soviets. He eventually ended up at the University of Chicago in the 1950s to become a leading scholar of business cycles and economic forecasting. Until his death in early 2009, he was on the NBER’s Business Cycle Dating Committee.
The informal rule that bears his name inspired a chart at the Atlanta’s Fed’s excellent Macroblog. The researchers compared the depth of recessions and the strength of recoveries over the past five decades, which is reproduced here. All else equal, the latest peak-to-trough decline of nearly 4% in GDP could be followed by growth of as much as 8% a year after the recession. However, assuming the NBER dates the new expansion somewhere around the end of 2Q09, the Philly Fed’s Survey of Professional Forecasters says annual GDP growth will be a scant 3% a year later. (If the NBER picks a later date, the consensus numbers are pretty much the same through the second half of the year.)
The Zarnowitz Rule is just as robust in other macro data sets. Industrial production, for instance, posted an overall decline of nearly 15% during the recession. After the first year of recovery, IP could be well into the teens, to judge both by history and by the strength of the ISM’s latest manufacturing survey. However, the consensus expects a modest 5%.
The plunge in nonfarm payrolls was a record-busting 5% from peak to trough. But rather than a record recovery, the consensus actually expects a continued decline of -1% in payrolls through mid-2010, which would be the labor market’s weakest post-recession performance.
Perhaps the most important deviation in the consensus forecast from the historical experience is corporate profits. NIPA post-tax profits plunged 40% from peak to trough. The Zarnowitz Rule suggests a robust recovery of possibly similar magnitude. In contrast, the Survey of Professional Forecasters predicts almost no recovery at all.
Earlier in his career, Victor Zarnowitz also compiled a landmark study of the accuracy of economic forecasts. At the time, he generally found them wanting.
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