## Posts

### Does the term spread predict a US recession?

Many commentators suggest that a negative term spread (inverted yield curve) in the US may signal an imminent recession, but other data is more positive. In this post, I use an R program jointly with the FRED data base to shed some light on the risk of a US recession.
Spurious correlation and a test for leading indicators Before we delve into data analysis, I want to emphasize a problem when eye-balling lead-lag relationships between GDP growth and potential leading indicators. If two time-series are persistent, meaning that they exhibit long-lasting cycles, we may wrongly conclude that one leads the other. In fact, if two time-series are persistent, we will likely find spurious correlation between the two when in fact there is no relationship.

To show this, let us first look at some simulated data. I simulated 1,000 observations for three persistent time series:

y(t) = 0.8y(t-1)+0.1x(t-1)+0.3e(t)
x(t) = 0.9x(t-1)+0.3v(t)
z(t) = 0.9z(t-1)+0.3n(t)
e(t), v(t), n(t) ~ i.i.d. N(0,1)

By const…