Goldman Sachs has a new model to track recessions and it sees a less than 25% chance of one soon

Key Points
  • Goldman Sachs' new model estimates the chance of a recession to be less than 25% in the next year.
  • The median economic forecaster currently estimates the probability of a recession at 35%.
  • Goldman's model downplays the significance of the yield curve and the notion that unemployment will spark inflation.
The Goldman Sachs booth on the floor of the New York Stock Exchange
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Goldman Sachs thinks other forecasters have flawed models to predict economic cycles including recessions.

The median U.S. economic forecaster predicts that there is a 35% chance of a recession in the next year. But Goldman believes this an overestimation and so the firm has created a new model.

Its new model estimates that there is less than a 25% chance that the economy will plunge into a recession in the next 12 months.

"We see several reasons why standard models — and thus forecasters — may be overestimating recession risk at present," wrote Jan Hatzius, Goldman's chief U.S. economist in a note Sunday.

Hatzius' new model includes adjustments for what he considers to be long term changes in the U.S. economy that others are missing including low interest rates and unemployment.

"Even fewer models allow explicitly for structural changes in the economy that affect both the overall frequency of recession and its drivers," he wrote.

The risk of the economy overheating — which occurs when growth is happening at an unsustainable rate — is measured through core inflation in the new model rather than indirectly based on the unemployment rate. In the past, such low unemployment has triggered inflation shock but that is not occurring this time.

Goldman Sachs also focuses on a short-end spread of the yield curve, minimizing the influence of the longer portion of the curve. Other models rely heavily on data related to the yield curve and inflation, which have successfully predicted recessions in the past.

Accounting for those changes, Goldman's new model sees just a 24% chance that a recession will begin in the next 12 months.

"This is up significantly over the past year, mainly because of a flatter yield curve and weaker current growth," the note states. "However, it remains below the probability estimates of the median forecaster and reinforces our view that the risk of recession remains moderate.

The S&P 500 hit an all-time high on Monday as earnings results in the last two weeks signaled that a recession was less of a concern.