Speaker 1: You mentioned trying to stop recessions, how do you do that? I mean it seems like everything is sick of doing something... Speaker 2: Well, I have a lot of thoughts on that. I wrote a book with George Akerlof called, "Animal Spirits" and it's about the psychology of markets and recessions. We concluded that, this isn't totally new but it's our reaffirmation that recessions are substantially psychological. So it's difficult for anybody, a central bank, central government to deal with them. It's just like, if you get depressed and go to a psychiatrist, don't expect to be cured overnight. Speaker 3: I have a question about inverted yield curves. So how did they occur and what do they mean about the state of the economy? Speaker 2: Well, an inverted yield curve is a situation in which short term interest rates, like overnight rates or three month rates, are above long term interest rates. That's not the usual situation because long term, obviously long term bonds are riskier because the payout is coming much later. So people generally demand a higher, and the market will give them a higher interest rate, but sometimes it's inverted. It's been shown statistically that that's a leading indicator of a recession. Historically, inverted yield curves tend to be followed by recessions. Right now we do not have an inverted yield curve but we're still talking about recession. So it still can happen. But why is an inverted yield curve predicting a recession? Well one thought is that recessions occur when people get pessimistic and they might get pessimistic about 10 years into the future. So we were just saying that government bond yields in Japan reached a negative number at the 10 year horizon. It's done that similarly in Germany and other European countries. So what does that mean? Well one thought is, it's just a long-term pessimism. You know? We've been in this financial crisis. It's worse in Europe than in the United States. We've been in it in Europe for, it's getting close to a decade and people are starting to think this isn't going to end. You know? We just don't have prosperity and they don't want to invest in new products. So there's just no demand for this. So the interest rate equilibrates at a very low level. The other thing though, historically, is that often central banks started recessions deliberately at times when inflation was getting out of control. That's not now but in history there were be times when inflation was just going through the roof and someone said, you know you've got to take tough medicine. Shoot the short rate up really high which is what banks can start a recession and that will bring the inflation rate down, and out of desperation they actually did that. So if that's the story of inverted yield curve it's not so promising in explaining the current situation when inflation is now a big factor generally. Speaker 3: So are there better gauges of recession in the bond market like say, the LIBOR–OIS spread or other basis who operates, it's like what are the good ones would you say? Speaker 2: Well, I don't like to... I mean, the stock market is the same as well. This is the most famous leading indicator and I tracked it back to the early 1920s. That's when people thought, started to really talk a lot about the stock market as a leading indicator. And I think it became a sort of self-fulfilling prophecy that afterwards in 1929, now people have been talking about stock market as a leading indicator. In 1929, we had the biggest one-day crash, and I think it was the biggest in history or very close to that, and so people thought that's a leading indicator. They started to worry about the depression and that encouraged that to actually happen. People stopped spending and stopped new investment projects. So that's the most famous leading example of it predicting correctly. So we have seen drops in the stock market after 2000 and it led to a recession after 2007 and it led to a recession. And now into 2016 we see some little drops. You know not close to 10% in the stock market. It's going to get people worried that this leading indicator is suggesting another recession, and it's not just U.S., it's all over the world. Stock markets have been dropping but it's still not clear yet because it hasn't dropped really a lot. It might correct upwards. It's very fuzzy and it's always fuzzy about recessions until they're really happening. Once the unemployment rates start shooting up. Then we pretty much know there's going to be a recession but it's that period before there is any clear indicators that it's just hard to predict recessions. Something, there's some kind of a turning point that happens when people suddenly think, this is it. You know it's a recession. I better batten the hatches and retreat and protect myself. And then business plans are canceled, people are laid off, hiring is shut down. You can see that when it's happening and you can predict it's going to get worse for a while. But at this moment we're not there. Speaker 3: So how do you see that in the bond markets specifically? Speaker 2: Well, Okay, so the bond market isn't known as much as a leading indicator as the stock market. And if I looked at what was happening in the long term bond market in 1929 for example, not as dramatic or in the housing market then. The stock market is the one that is most famous for predicting but you know it's a fundamental fact though that recessions are just hard to forecast. Speaker 3: Not for you. (laughing) Speaker 2: Well, I think it's a little bit like predicting the success of a movie. If I were to show you a private screening of the next movie about to be launched, could you predict whether it would be a hit or not? You know, I think you might think you can but nobody really well can. You know these things... Even some of the most famous operas for example, they flopped on their first performance and people thought they were terrible but somehow public opinion has its own life in it. So in our book Animal Spirits, Akerlof and I emphasized how it's really a kind of contagion of emotion that takes place about a movie for example or a song, and that's human nature, and so you can sometimes predict but not reliably.