Accurately predicting recessions, like accurately predicting anything, is hard to do. But the Fed has to try in order to reach its goals of stable prices and maximum employment.
In hindsight, it’s easy to spot some patterns around recessions. For example:
Still, figuring out in “real time” when we are in a bubble is difficult, said David Wheelock, vice president and deputy director of research at the St. Louis Fed. And in any case, not every boom-bust cycle has been followed by a recession.
The same is also true of the other patterns: Not all inversions or oil price increases led to recessions.
“Unfortunately, there’s no single variable that always tells us we’re on the verge of a recession or not,” Wheelock said.
Wheelock said the Fed keeps an eye on a variety of signs. These include:
Rapidly rising asset prices may signal a bubble and an overheating economy—the boom before a bust. The Fed can combat the cycle by raising interest rates, or “tightening” monetary policy, to slow the growth of spending.
A former Fed chairman, William McChesney Martin Jr., compared that part of the Fed’s job to ordering the punch bowl removed “just when the party was really warming up.”
In the case of an overheating economy, it may be appropriate in some circumstances to tighten monetary policy, Wheelock said.
“And take away the punch bowl.”