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Barometric models These models identify patterns among variables over time. That is, you try to find time series variables that “signal” future changes in the business climate.

Barometric models

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Barometric models. These models identify patterns among variables over time. That is, you try to find time series variables that “signal” future changes in the business climate. Forecasting Using Economic Indicators. Outline: - PowerPoint PPT Presentation

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Page 1: Barometric models

Barometric models

These models identify patterns among variables over time. That is, you try to find time series variables that “signal” future changes in the business climate.

Page 2: Barometric models

Outline:

1. Components of the Conference Board’s leading, coincident, and lagging economic indicators.

2. Conference Board selection criteria

3. The record of the Leading Index in predicting recession and recovery.

4. The Ratio Index

Page 3: Barometric models

The Leading Index (CLI)

•The Composite Index of Leading Economic Indicators (CLI) is selection of time series variables that more often that not “lead” the cycle—that is, they tend to be in decline some months prior to a business cycle peak and tend to start rising months prior to a trough.

•A discernible downturn in the CLI is a predictor of a coming recession.

•An upturn in the CLI is an indication that the recession is nearly at an end.

Page 4: Barometric models

Components of the Leading Index 1. Average weekly hours, manufacturing

2. Average weekly initial claims for unemployment insurance

3. Manufacturers' new orders, consumer goods and materials (in 1996 $)

4. Vendor performance, slower deliveries diffusion index

5. Manufacturers' new orders, non-defense capital goods (in 1996 $)

6. Building permits, new private housing units

7. Stock prices, 500 common stocks

8. Money supply (M2) (in 1996 $)

9. Interest rate spread, 10-year Treasury bonds less federal funds (yield curve)

10. Index of consumer expectations

Page 5: Barometric models

Conference Board selection criteria for the CLI

•Timing. Does the series have turning points spaced at lengthy intervals from cycle peaks and troughs, and is it consistent? The longer and more consistent the lead time, the higher the score for timing.•Conformity . How often does the series give off false alarms of impending turning points in the cycle? •Smoothness. Is the series choppy or erratic? •Currency. Is the most recent data readily available?•Statistical Adequacy Rates the quality of the reporting system.•Economic Significance.Does the time path of this series make sense (at the level of theory) as a predictor of the future level of economic activity? •Revisions. Is there a strong likelihood that the most recently available data will be subsequently revised?

Page 6: Barometric models

Criterion Weight Score

Timing 0.267 94Conformity 0.167 65

Smoothness 0.133 80

Currency 0.100 100Statistical adequacy

0.067 80

Economic Significance

0.167 80

Revisions 0.100 100

•Overall score is 85.

•By way of comparison, the score for sensitive material prices is 66.

Page 7: Barometric models

Weights of the components of the CLI

Component Weight

Average weekly hours, manufacturing .184

Average weekly initial claims for unemployment insurance .025

Manufacturers' new orders, consumer goods and materials .050

Vendor performance, slower deliveries diffusion index .028

Manufacturers' new orders, non-defense capital goods .013

Building permits, new private housing units .019

Stock prices, 500 common stocks .031

Money supply, M2 .301

Interest rate spread, 10-year Treasury bonds less federal funds

.332

Index of consumer expectations .018

Page 8: Barometric models

Recession months are shaded

Page 9: Barometric models

Recession months are shaded

Page 10: Barometric models

100

102

104

106

108

110

112

1997 1998 1999 2000 2001

U.S. Index of Leading Indicators, 1987 = 100

CLI led March 2001 peak by 14 months

-14

Page 11: Barometric models

The CLI: How reliable are they?

•From 1948 to 1988, the revised index of leading indicators had a average lead of 9 ½ months at business cycle peaks.

•Lead times at peaks ranged from 2 to 20 months.

•At business cycle troughs, the average lead is 4 ½ months.

•Lead times at troughs ranged from 1 to 10 months.

•The CLI set off false alarms of an impending business cycle peak and contraction in 1966 and again in 1984.

Page 12: Barometric models

The CLI will tell you a recession or recovery is coming—but you won’t know when. Could be a

month, or it could be 18 months. Also, a sharp decrease in the

CLI (in percentage terms) does NOT necessarily mean the

forthcoming recession will be a severe one.

Page 13: Barometric models

1. Employees on nonagricultural payrolls(weight = .479)

2. Personal income less transfer payments (weight = .283)

3. Industrial production (weight = .129)

4. Manufacturing and trade sales (weight = .109)

Recall we said the NBER looks to

these indicators to date cycle peaks

and troughs.

Page 14: Barometric models

Recession months are shaded

Page 15: Barometric models
Page 16: Barometric models

1. Average duration of unemployment (weight = .037)

2. Inventories to sales ratio, manufacturing and trade (weight = .123)

3. Labor cost per unit of output, manufacturing (weight = .062)

4. Average prime rate (weight = .243)

5. Commercial and industrial loans (weight = .128)

6. Consumer installment credit to personal income ratio (weight = .221)

7. Consumer price index for services (weight = .186)

Page 17: Barometric models

Recession months are shaded

Page 18: Barometric models

The Ratio Index (RI)

•Let C denote the composite index of coincident indicators.

•Let L denote the index of lagging indicators.

•The ratio index is given by:

RI = C/L

Page 19: Barometric models

68

70

72

74

76

78

80

60

70

80

90

100

110

79:01 79:07 80:01 80:07 81:01 81:07 82:01 82:07 83:01 83:07 84:01

Ratio Index Times 100Index of lagging IndicatorsIndex of Coincident Economic Ind

Recessions are shaded

Page 20: Barometric models

85

86

87

88

89

90

68

69

70

71

72

73

74

79:07 80:01 80:07 81:01 81:07 82:01 82:07 83:01

Index of Leading IndicatorsThe Ratio Index

Page 21: Barometric models

NBER-dated Peak CLI Lead (months) Ratio Index Lead (months)

July 1953 5 9August 1958 20 27

April 1960 10 12Dec 1969 8 13Nov 1973 8 11Jan 1980 15 21July 1981 2 9July 1990 6 6

Ave. = 9.3Std. Dev. = 5.8

Ave. = 13.5Std. Dev. = 7.0

Comparing the Performance of the CLI and the Ratio Index in Predicting Post-War Recessions