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Official release of the recession indicator temporarily suspended: A sharp decline in the leading index due to the Coronavirus crisis distorts the probability

－ Until the estimation method is revised, the reference value will continue to be calculated
－ The reference value for April is 59.4%

Takashi MIYAZAKI

  Senior Economist

2020/06/10

  The real economy has deteriorated significantly due to the spread of COVID-19. The leading index in the business conditions index published by the Cabinet Office, which is the underlying data for calculating the recession probability, reached 76.2 in April, a reduction of 8.9 points from the previous month, recording the largest decline since the statistics started in 1985. The unprecedented sharp decline in the leading index distorted the calculation of the recession probability and decreased in April. This distortion may instigate fear of a misleading signal for the future economic outlook. Therefore, we decided to revise the estimation method to indicate the economic prospect more appropriately. Accordingly, the official release of the recession probability has been temporarily suspended. Until the estimation method is revised, the recession probability will be calculated as a reference value and posted on this website.

Reference value: The recession probability in April is 59.4%

  In the methodology of the recession probability, the transition probability to an expansion phase usually increases with the length of the recession period. In addition, the recession probability tends to reflect a case where the leading index often rebounds when it has dropped significantly in the past. Therefore, even though the recession probability rose to 99.9% in March (estimated in May), taking the bottoming-out of the leading index into account, the probability dropped retroactively by the revision in this month, incorporating the leading index in April. The probability reached 59.4% in April (Fig. 1). In fact, in the periods from the latter half of 2008 to the beginning of 2009 (immediately after the Bankruptcy of Lehman Brothers) and in the latter half of the recession in 2012, there were some cases where the recession probability fell in advance, while the leading index continued to decline.

Figure 1: Recession probability (59.4% in April 2020, reference value)

  We made adjustments to allow for a sharp decline in the leading index due to COVID-19 to be calculated as the recession probability. Even with this adjustment, future risks are not fully reflected, such as the second wave of infections, intensifying U.S.-China friction, and civil unrest in the United States. This indicator may originally give a false signal, but it aims to provide an early signal, with an emphasis on anticipation for economic trends (Miyazaki, 2016). It is possible for a recent decrease in the probability in this phase to be judged as a false signal, ex post. For now, we will continue to calculate the recession probability as a reference value.

＜Reference＞
    Miyazaki, Takashi., 2016, “Estimating a recession probability in Japan using the Composite Index: An approach employing a Markov-switching model,” JCER Discussion Paper No. 145. (in Japanese).