The above chart displays Chauvet and Piger’s “smoothed recession probabilities” index from January 1, 1980 onward. The gray bars represent recessionary periods as determined retrospectively by the NBER.
The index is based on a Markov-switching dynamic factor model that incorporates four variables: non-farm payroll employment, the index of industrial production, real personal income excluding transfer payments, and real manufacturing and trade sales.
The recession probabilities in this index are “smoothed” because the calculations are subsequently revised as new data become available. The most recent probability on the index is therefore a “real-time” probability whereas historical probabilities have been smoothed with updated data.
Since it predicts the onset of recession in real time, Chauvet and Piget’s index should be viewed as more of a contemporaneous indicator than a leading indicator of recessions. In other words, it is designed to tell us when we are currently in a recession rather than whether a recession is on the horizon six or twelve months from now. Treasury yields and composite leading indicators are better at predicting future shifts in the business cycle.