by Don Alexander, MBA
Associate, RSD Solutions Inc.
The author, Nicholas Bloom, in a short communiqué (VOXEU, August 22nd updated from August 9th) notes the increased risk of recession and predicts a short downturn in the next 6-12 months and a recovery in 2012. A number of Wall Street analysts place the probability of a double-dip recession around 30-35%. The short note of Bloom’s introduces other tools to forecast recessions. The potential explosive combination of Eurozone debt contagion, vulnerable banking systems, and European and American political paralysis has pushed stock-market volatility, as measured by the VIX, to levels nearly as bad as the days following the 11 September 2001 terrorist attacks and early onset of the 2007-09 crises. Bloom starts with looking at the VIX as a traditional measure of market uncertainty or what he calls a fear factor. The author introduces alternative measures of potential volatility, such as the frequency of news headlines or the use of the word “uncertainty”, and finds these measures elevated. The role of news, headlines or specific words are additional information now being incorporated into credit models. Nobody knows what happens next? How long will the current stock-market panic last? This column reviews research by the author on 16 previous episodes of uncertainty shocks (going back to the 1950s) and concludes that today’s uncertainty shock will create a short, sharp contraction. He notes that uncertainty shocks have a 1.9 month life (it takes about two months for volatility to decline by 50% from the peak). Hence, the current panic has another six weeks to run based on historical data. During a period of uncertainty, hiring and new investment grind to a halt with the durable goods sector being the most severely impacted. Bloom is negative in the short-term, but positive over a long-term horizon. He notes that the current uncertainty may force the necessary structural reforms in Europe and the US, while growth in China and India may offset some of the adjustment costs. The author provides specific metrics from his research of a 1% contraction in late 2011 and a rebound in late 2012. This research looks at the average impact of the previous 16 uncertainty shocks to predict the impact of future shocks. Typically these leads to reductions of growth of about 2% immediately after the shock, with a recovery about six months later once uncertainty subsides. The author notes that early work in this area was done by the current Fed chairman (Bernanke 1983). What risks do you face in a double-dip recession? For more on this click on the link: www.voxeu.org/index.php?q=node/6846
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