The most recent recession (excluding the recent impact of Covid-19) was the 2008 Great Recession caused by the housing crisis and fuelled by banks’ excessive and risky loans. A group of bankers and economists have gained widespread recognition for their ability to see this recession coming years before it actually happened and, to many experts’ surprise, were able to use the crisis to their advantage and profit from it. But how can someone see a recession coming? The short answer, as it turns out, is statistics.
The most typical indicator people refer to when predicting a recession is the Bond Yield inversion, which is when long-term bond yields are less than short-term bond yields. This can be seen in the following graph: when the 10-year bond is worth less than the 2-year bond, it is negative on the Y- axis.
These negative periods come just before recessions which are shown as the grey regions. The explanation for this pattern is quite simple. As peoples’ faith in stocks and pension funds as a viable way to save money decreases, they look for more stable ways to save money at a low risk and higher gain, and surges in demand occur as a result. When demand for government bonds increases, the price increases to match it, but since the price is inversely proportional to the yield, the yield ultimately falls. Essentially, when there is a yield inversion it demonstrates that people are shifting their money toward stable investments, and given that a decrease in investment is a crucial component in the fall of aggregate demand and therefore a recession, this proves to be a valuable asset in predicting imminent crashes. This is a prime example of a causal leading indicator for recessions.
But how are these indicators found? How might economists find or predict the next recession? In a world where 2,500,000,000 GB of data is produced every day, certainly, the answer lies there. Using this information I set out to find my next economic recession indicator. Using data from various websites and statistical databases, I constructed a spreadsheet using various economic indicators: the debt to income ratio, 10 - 2 year bond yields, the price of gold, and the Anxious Index from the last 42 Years spanning 4 recessions. The challenge was to find a correlation within certain statistics worthy of being a reliable indicator. Surprising correlations between the key economic indicators previously listed were found with unemployment in countries where the main export is coffee, but it was not fully correlated and was caused by recessions in the USA (the main importer of coffee). Finally, a worthy indicator was found: Relative Importance Weights (Contribution to the Total Industrial Production Index): Manufacturing: Non-Durable Goods: Ice Cream and Frozen Dessert. In other words, quantity of ice cream consumed as a percentage of all frozen desserts (the Ice Cream Index). With a PMCC of 0.3691 to the yield indicator and a PMCC of 0.5062 to the debt to income indicator, the Ice Cream Index was what I was looking for.
But how can ice cream consumed as a percentage of total frozen desserts predict future recessions? Ice cream has forever been a solution to many problems; for example when the equatorial heat arrives in Madrid during summer days, the solution to the burning heat is an ice cream cone. What is more, during emotional times it has been scientifically proven that ice cream creates happiness. Neuroscientists at the Institute of Psychiatry in London scanned the brains of people eating vanilla ice cream. They found an immediate effect on parts of the brain known to activate when people enjoy themselves; these included the orbitofrontal cortex, the "processing" area at the front of the brain. Ice cream is a resource the brain turns to when in need of happiness or a distraction. This is where the link is to economic recessions, as we can see from the data as an economy approached the 1981-82 recession (shown in red) the Anxious Index6 increased (a coefficient showing the probability of a decline in real GDP in the quarter following the quarter in which the survey is taken.) As people's anxiety increased their propensity to consume ice cream also increased; thus the amount of ice cream consumed as a percentage of total frozen dessert consumption increased.
We can also relate the ice cream index to other frozen goods and compare the differences. Other frozen desserts include frozen yogurt, confectionery candy, and cold-served cakes. When comparing ice cream prices per gallon in 2016 to cake prices in 2016, the average price of ice cream per gallon was $5.8710 compared to a minimum of $15.00 up to or exceeding $100.0011 for cold served cakes. Looking at desserts, buying a cake is a luxury good whereas a gallon of ice cream is a normal good. On the other side of the spectrum, frozen yogurt, ice cream's closest cousin, also has a similar style of consumption as ice cream; it is usually bought in stores where the customer is directly served. The average price for a medium-size frozen yogurt is $5.2512 whereas with ice cream the average price is $3.9913. Establishing the fact that ice cream is a normal good and inferior in comparison to other desserts is important in realising why the Ice Cream Index predicts recessions. When GDP is decreasing as a recession approaches, the debt to income ratio increases as more people go into debt, and as a result, when choosing a dessert, will subconsciously choose ice cream over other desserts because it is cheaper but still loved by the majority. Therefore, in times where GDP is decreasing and unemployment is potentially rising, the ice cream index will increase.
But is this indicator perfect? Why might it not work? When studying economics it is important to evaluate what you are assessing and include why the policy or indicator might not work and what are its weaknesses. The most obvious criticism of my methodology in using the ice cream index as a recession indicator is the fact correlation is not equivalent to causation; just because there is a correlation between ice cream consumption and other recession indicators does not mean it can itself predict recessions. One would have to see when that data on ice cream consumption is available, if the increase in consumption is ahead of consumption it is a predictor if not it's just correlated.
Another factor that influences the ice cream indicator is trends. Ice cream as well as many other desserts goes in and out of fashion, which can directly influence the credibility of the indicator. For example, if an ice cream substitute becomes quite trendy, the consumption of ice cream as a percentage of desserts will decrease, but this does not mean that a recession is coming, only that a trend has changed. Nevertheless, although this is true, the demand is so large for ice cream and its production is so varied, that taking all of this into account, the main influence on the percentage of ice cream consumed compared to other frozen desserts is still the state of the economy; how stressed people are or how imminent a fall in GDP may be.
Marcos L, Year 12
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