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 eading
the financial press, there is considerable talk as to whether the
economy is sliding into a recession. Traditionally, a recession
has been signaled by two quarters of negative declines in gross
domestic product GDP. However, the information on GDP is available
only with a considerable lag. There is a litany of reports: the
preliminary GDP numbers come out approximately two months after
the quarter ends; a month later revised estimates are made available.
The official economic data is available only after the fact.
Economists
and investors alike have a need for quick ways to infer whether
the economy is slowing. Only then can they make quick inferences
as to whether the economy is responding favorably to monetary and
fiscal policy changes enacted by the authorities. To this end, economists
and analysts have searched and identified a number of indicators
(or what are called contemporaneous indicators) that they use to
make inferences as to the current state of the economy. Other indicators
are used to predict the future path of the economy (the forward-looking
or leading indicators). The question to ask is whether the indicators
deliver what their developers or users claim. Let's look at some
popular indicators.
The financial
press reports a number of variables available on a monthly basis,
a frequency higher than that of the release of new GDP numbers.
There is also no significant lag in obtaining the data, it is almost
available in real time. The fact that the data is available earlier
and with a higher frequency makes them useful real-time indicators
of economic conditions, as well as a good predictor of what GDP
figures will be after the quarter ends. It is important to note
that these are not "leading indicators," they are contemporaneous
variables that happen to be available before GDP data becomes available.
Thus, the value of these indicators as forecasting tools results
only from the delay in the availability of GDP numbers. In short,
these variables are coincident indicators of the path of the economy.
The most commonly
used contemporaneous indicators are the Industrial Production Index,
the Capacity Utilization Index, the Employment Index, and the Unemployment
Rate. Looking at the chart below, it is apparent that the rate of
change in the Industrial Production Index tracks the real GDP growth
rate fairly well. The peaks and troughs in the two series match
each other quite well. The one difference seems to be that the amplitude
of the Industrial Production Index is greater than that of real
GDP growth.
The Capacity
Utilization Index is presumed to show how close the economy is to
its maximum level of production. It is like the employment rate
of the economy's machinery. The Capacity Utilization rate and the
Employment Rate (both charted below) are both closely related to
the economy. However, upon inspection it is apparent that the match
is not perfect and if there is any predictability offered here it
is that real GDP appears to lead the two variables slightly.
Since we use
both capital and labor to produce output, a portfolio analogy applies.
We can view the economy as a portfolio of two "assets:"
capital and labor services. To the extent that the two "assets"
are not perfectly correlated, the volatility of the portfolio (i.e.,
real GDP) will be reduced when both are included in the portfolio.
This suggests that looking at Capacity Utilization and the employment
rate jointly will give a better and more precise estimate of current
economic conditions. Since employment is inversely related to the
unemployment rate, adding the latter to the analysis will only produce
a relationship that is the mirror image of the employment rate without
adding any additional information. Thus, whether one chooses to
add the unemployment rate to the analysis (as in the chart below)
is a matter of personal preference.
Whatever course
you choose, the contemporaneous indicators deliver what they promise:
a good gauge of the current economic conditions. And they can also
be an aid in predicting what the GDP will be (upon release) for
the current quarter.
Go to "Economic
Tea Leaves, Part
II"
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