Calling a European recession

“Is the first zone wide recession in the short history of the eurozone about to be registered?” asks Edward Hugh. I was curious to apply the algorithm for calculating my U.S. recession indicator index to a euro area GDP measure to get an answer.

We don’t have a long enough time series on the European Union to estimate the parameters characterizing expansion and contraction. But I wondered what would happen if you take the parameter values estimated on the basis of 60 years of U.S. real GDP growth rates and just apply them directly to the European data. That procedure is not immune from criticism. European growth rates are lower than the U.S., meaning that the algorithm may be a little too quick to call a recession with the European data, since it is expecting to see stronger growth rates in an expansion. On the other hand, we know the values of these parameters pretty well for U.S. data, and using prior information from another sample in this way can eliminate a lot of the statistical noise that would complicate an effort to start from scratch on the European data. So I was interested to take a look.

The top panel in the figure above plots the quarterly Euro-15 real GDP growth rate for each quarter at an annual rate, while the bottom panel reports the recession indicator index. It is interesting that the algorithm would have characterized Europe as being in a recession in 2002 following the U.S. downturn in 2001, if you adopt my rule of making a call when the index exceeds 67%.

I’m also following the procedure I use with U.S. data of waiting to see one extra quarter of data before trying to make a call. So for example, the most recent entry in the bottom panel is for 2008:Q1, when the recession indicator index for Europe is up to 32.8%. For comparison, the 2008:Q1 indicator for the U.S. is 38.4%

If this was a contest between the U.S. and Europe to see who’s going to get there first, it just reached the point where it’s about to get interesting.

Originally published at Econbrowser and reproduced here with the author’s permission.