The quest for early indicators
of turning points in economic
conditions: how the official
statistics is involved?
Gian Paolo Oneto
ISTAT
International Seminar on Timeliness, Methodology and
Comparability of Rapid Estimates of Economic Trends
Ottawa, 27-29 May 2009
The quest for early
indicators of turning
points in economic
conditions …
Outline
1. Defining the problem at hand: what signal users are
looking for?
2. The role of timeliness and its relationship with reliability
3. (a digression) An often misunderstood feature of ShortTerm (ST) indicators: volatility.
4. The boundary between flash estimates, real time
estimates (nowcasting) and forecasting: a central issue
of Official Statistics (OS).
5. The search for leading indicators: mixing ST indicators
with other sources.
6. A couple of possible ways forward: investing on the
production of statistical indicators with leading
properties; improving the quality of survey data.
Ottawa, 27-29 May 2009
2
1. Defining the problem at hand:
what signal users are looking for?
The quest for early
indicators of turning
points in economic
conditions …
The real features of the demand of high frequency economic
information that is emerging from professional users and the public
at large should be clearly identified
Indeed the recent developments of the economic situation are stressing
the need of timely statistics able to monitor the evolution of the Business
Cycle (BC). Quarterly national accounts, activity indicators, labour input,
prices, foreign trade data are the target domains, and the timeliness
requirements are set by the best international standards. In turn, the
information provided by ST indicators is often regarded as lagging behind
the “real question” that is haunting analysts and policy makers: are early
signals of the recovery in sight?
The crucial issue in front of large swings in economic conditions
seems to be the detection “as soon as possible” of the inception of
a turning point in the BC
If this is the case, the problem at stake is not just timeliness: we need to
understand how to channel this demand, disentangling the pressure for
more timeliness (more early estimates) of ST economic indicators from
the interest in indicators with leading properties.
Ottawa, 27-29 May 2009
3
2a. The role of timeliness and
its relationship with reliability
The quest for early
indicators of turning
points in economic
conditions …
As far as the main ST indicators are concerned (Quarterly GDP, IPI,
retail trade, CPI, output prices, etc.) the benefits of improving
timeliness are quite clear, as shown by the Eu experience
In tracking correctly the BC evolution a large set of timely indicators is
needed.
In this respect, the evolution of the European System of ST indicators is
very interesting: assigning high priority (and reasonable resources) to
this target, a good level of timeliness for key indicators has been
achieved:
45 days delay for flash estimate of GDP, 40 days for IPI, 30 for industrial
output prices, 45 for IP in construction, 30 days for retail trade, 0 day for
CPI flash.
Additional requirements are pending: the availability of timely indicators
of labour market development, and indicators of service activity.
Ottawa, 27-29 May 2009
4
2b. The role of timeliness and
its relationship with reliability
The quest for early
indicators of turning
points in economic
conditions …
Moving along the trade-off between timeliness and reliability
(measured in term of revision error) is a process that must be
undertaken with a clear assessment of the possible costs
The information benefit of improving the timeliness of well established
ST statistics (GDP, IPI) must be assessed, in terms both of feasible
timeliness gains and of possible losses due to the worsening of the
signal to noise ratio (larger revisions).
Moreover, can timeliness help with respect to the issue of gauging
early signals of turning points (or acceleration/slowdowns) of the
BC?
Taking as starting point the Eu situation (that is slightly less favorable
for users than the one in the US) the timeliness gain does not seem
the crucial factor affecting BC monitoring.
The current targets (improving to 30 days the timeliness of GDP and IPI
estimates, producing flash estimates for employment and LCI) can be
judged as the medium-term limits to feasible improvements, unless
large-scale jumps in the production process are envisaged.
Ottawa, 27-29 May 2009
5
2c. The role of timeliness and
its relationship with reliability
The quest for early
indicators of turning
points in economic
conditions …
GDP estimates cannot be reasonably advanced further unless a
substantial set of activity indicators are available at less than 30 days (in
this respect the volatility of activity measures is crucial; going toward
monthly estimates of GDP could be an alternative long-term strategy).
As a result, I would argue that the feasible improvements (given current
resources and statistical infrastructure) in timeliness can play a small role
in advancing the monitoring of turning points of the BC.
To be clear: to identify an upturn/downturn of the BC the last q-o-q rate of
change of GDP is strictly insufficient; it must be supplemented by a quite
large span (6 months?) of ST indicators (IPI, production in construction,
turnover in services, employment) in order to compensate for the
uncertainty (due more to volatility that to the typical revision error).
Ottawa, 27-29 May 2009
6
3a. An often misunderstood feature of
ST indicators: volatility.
The quest for early
indicators of turning
points in economic
conditions …
Almost every ST indicator of economic activity is affected by an high
degree of volatility. This feature is inherent to the underlying economic
processes and/or to the measurement methods.
The indicators currently utilized to monitor the BC (in particular monthly ones)
have high frequency components (noise) that hide the underlying cyclical signal.
This is a well known feature that in the classical literature on BC was treated
with specific instruments: the MCD (Months for Cyclical Dominance) criteria was
considered a kind of label to be associated to each indicator.
For instance the total IPI of EMU and 3 largest Countries has an MCD ranging
from 2 (for the Euro area total) to 4 (for France).
The MCD increases rapidly using sector breakdowns: considering the 5 Main
Industrial Groupings of the IPI index, the MCD value is never lower than 3,
ranges in a large share of case between 4 and 5, going up to higher values for
the energy sector.
Ottawa, 27-29 May 2009
7
3b. An often misunderstood feature of
ST indicators: volatility.
The quest for early
indicators of turning
points in economic
conditions …
In assessing the actual timeliness of an indicator the span of monthly data
that are needed to extract a meaningful signal must be taken into account.
Moreover, the issue of minimising volatility must be dealt with in the phase
of treating (filtering) the time series
There are important implications of high volatility: the gain of high frequency
indicators (monthly vs. quarterly) is low; filtering the noise component implies a
loss of timeliness, as the cyclical signal emerges only averaging a long span of
data.
In turn, the volatility can be lowered improving the utilization of efficient
procedures of Seasonal Adjustment that, indeed, are crucial to any identification
of the cyclical movements of ST indicators as well as to measuring correctly their
movements.
Ottawa, 27-29 May 2009
8
The quest for early
indicators of turning
points in economic
conditions …
The evolution of key indicators (GDP, IPI) around a turning
point of the (classical) BC in the EMU (1)
Quarterly GDP and monthly IPI in levels (standardised ) at the end of the 1991/92 recession
EURO AREA (15)
GERMANY
2
2.5
2
1.5
1.5
1
1
0.5
0.5
0
0
-0.5
-0.5
-1
-1
-1.5
IPI
-1.5
IPI
GDP
-2
Sep-92
Dec-92
Mar-93
Jun-93
Sep-93
Dec-93
Mar-94
Jun-94
Sep-92
Dec-92
Mar-93
FRANCE
Jun-93
Sep-93
Dec-93
Mar-94
Jun-94
Sep-93
Dec-93
Mar-94
Jun-94
ITALY
2
3
2.5
1.5
2
1
1.5
0.5
1
0
0.5
0
-0.5
-0.5
-1
-1
IPI
GDP
-1.5
IPI
GDP
-1.5
Sep-92
Dec-92
Mar-93
Jun-93
Ottawa, 27-29 May 2009
Sep-93
Dec-93
Mar-94
Jun-94
Sep-92
9
Dec-92
Mar-93
Jun-93
The quest for early
indicators of turning
points in economic
conditions …
The evolution of key indicators (GDP, IPI) around a not-so-well
defined turning point of the EMU BC (2)
Quarterly GDP and monthly IPI in levels (standardised ) at the end of the 2001 recession
EURO AREA (15)
GERMANY
2
2.5
1.5
2
1.5
1
1
0.5
0.5
0
0
-0.5
-0.5
-1
-1.5
-1
-1.5
IPI
GDP
-2
IPI
GDP
-2
Mar-01
Jun-01
Sep-01
Dec-01
Mar-02
Jun-02
Sep-02
Dec-02
Mar-01
Jun-01
Sep-01
FRANCE
Dec-01
Mar-02
Jun-02
Sep-02
Dec-02
Mar-02
Jun-02
Sep-02
Dec-02
ITALY
1.5
2.5
2
1
1.5
0.5
1
0
0.5
-0.5
0
-0.5
-1
-1
-1.5
-1.5
IPI
GDP
-2
IPI
GDP
-2
Mar-01
Jun-01
Sep-01
Dec-01
Ottawa, 27-29 May 2009
Mar-02
Jun-02
Sep-02
Dec-02
Mar-01
10
Jun-01
Sep-01
Dec-01
The quest for early
indicators of turning
points in economic
conditions …
The evolution of key indicators (GDP, IPI) around the most
recent turning point of the EMU BC (3)
Quarterly GDP and monthly IPI in levels (standardised ) at the end of the 2005/07 expansion
EURO AREA (15)
GERMANY
1.5
1.5
1
1
0.5
0.5
0
0
-0.5
-0.5
-1
-1
-1.5
-1.5
-2
-2
-2.5
-3
-2.5
IPI
GDP
-3.5
IPI
GDP
-3
Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09
Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09
FRANCE
ITALY
1.5
1
1
0.5
0.5
0
0
-0.5
-0.5
-1
-1
-1.5
-1.5
-2
-2
-2.5
-2.5
-3
-3
IPI
GDP
-3.5
IPI
GDP
-3.5
Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09
Ottawa, 27-29 May 2009
Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09
11
The quest for early
indicators of turning
points in economic
conditions …
4. What are the boundaries between flash estimates,
real time estimates (nowcasting) and forecasting?
When OS enters the domain of flash estimates, the awkward issue of
defining the limits of the estimation process must be faced.
A tentative (personal) definition: flash estimate disseminated by OS are
estimates based on an information set including actual data (i.e. data measured
directly from respondents, via surveys or administrative files) referring at least in
substantial part to the whole reference period. In other words, no part of the
reference period (e.g. the last month, when quarterly data are concerned; the
second part of the month, as for monthly indicators) can be measured only
indirectly, through the relationship with other variables or by using projections.
If the above definition holds, objects labeled “real time estimate” (usually
for GDP or IPI) seem ill defined in the realm of OS, while the label
nowcasting should apply to a specific typology of forecasting approaches
(but should the OS be involved in forecasting?).
In particular when measures of economic activity are targeted, a short delay
inherently due to the measurement process has to be accepted. Collapsing this
delay is tantamount to use forecasting devices based on the information set
measured before the reference period: in this case how forecasts produced by
OS differs from other professional forecasts?
Ottawa, 27-29 May 2009
12
5. The search for leading indicators:
mixing ST statistics with other sources
The quest for early
indicators of turning
points in economic
conditions …
Flash estimates are a crucial instrument in monitoring the ST
developments but do not seem the answer to the rising demand for
indicators conveying advanced signals of turning points of the cycle.
A part of the information demand points at the well established approach
of Leading Economic Indicators (LEI); however this approach in recent
years had not received much attention, in particular from OS.
In the identification of leading indicators to be included in CLI (composite LEI),
all kind of indicators can be involved: aggregate and sector specific ST
indicators, money and credit variables, foreign trade data, expectations related
indicators (measured by business survey data).
Building and maintaining a system of LEI is valuable not only because of the
forecasting properties of the CLI itself but as a structured way of analyzing the
BC properties of the whole set of available indicators.
Then, considering the possibility of investing in programs aimed at the
identification/selection of leading indicators seems worthwhile for OS.
Ottawa, 27-29 May 2009
13
The quest for early
indicators of turning
points in economic
conditions …
6a. Is there room for improving the production of
ST indicators with potentially leading properties?
One of the possible ways forward is to target the leading properties as one
of the features that must be considered in developing (or improving) ST
indicators
Recently in the European Statistical System the issue of the quality of
industrial new orders data and of building permits indicators has been
discussed starting from the very problem that their leading properties
appears to be insufficient.
More analysis need to be developed about those indicators to fully
understand if their limits derives from measurement practices of from
the underlying behavior of economic agents.
A domain where the role of leading indicators of economic activity is still
very scarce is the service sector: may be there is scope for
investigating the possibility of measuring demand related variables.
Ottawa, 27-29 May 2009
14
The quest for early
indicators of turning
points in economic
conditions …
6b. Another possible development in the production of
leading indicators: improving the quality of survey data.
A key aspect that emerges from the current practices in both the leading
indicators approach and the standard ST forecast modeling is the central
role of survey data (business tendency and consumer sentiment data)
In this respect it is time to recognize that the quality aspects of the current
practices prevailing in the production of such indicators are worth to be
investigated from the point of view of the OS criteria.
The Ue setting, with a comprehensive program of survey data production, is
already advanced in terms of comparability across countries, but could be
further improved through coordination with the standard statistical production (for
instance, concerning industry classification, reference years and variables to be
utilized in the weighting structure).
There is the perception that outside Eu the statistical underpinnings of survey
data are even less comparable to the OS standards.
All in all, there is the possibility that investing on the quality of survey data
indicators their leading properties could be further improved.
Ottawa, 27-29 May 2009
15
The quest for early
indicators of turning
points in economic
conditions …
An example of leading indicators of the IPI cycle drawn from
survey data (Industry business tendency) - 1991 turning point
Industrial production (IPI), Orders and Production Expectations (survey data);
in levels (standardised )
EURO AREA (15)
GERMANY
2.5
2.5
2
2
1.5
1.5
1
1
0.5
0.5
0
0
-0.5
-0.5
-1
-1
IPI
ORDER
EXP-prod
-1.5
-1.5
IPI
ORDER
EXP-prod
-2
Sep-92
Dec-92
Mar-93
Jun-93
Sep-93
Dec-93
Mar-94
Jun-94
Sep-92
Dec-92
Mar-93
FRANCE
Sep-93
Dec-93
Mar-94
Jun-94
Sep-93
Dec-93
Mar-94
Jun-94
ITALY
2.5
3
2
2.5
1.5
2
1
1.5
0.5
1
0
0.5
-0.5
0
-1
-0.5
-1.5
Jun-93
IPI
ORDER
EXP-prod
-1
-2
IPI
ORDER
EXP-prod
-1.5
Sep-92
Dec-92
Mar-93
Jun-93
Ottawa, 27-29 May 2009
Sep-93
Dec-93
Mar-94
Jun-94
Sep-92
16
Dec-92
Mar-93
Jun-93
The quest for early
indicators of turning
points in economic
conditions …
An example of leading indicators of the IPI cycle drawn from
survey data (Industry business tendency); 2008 turning-point
Industrial production (IPI), Orders and Production Expectations (survey data);
in levels (standardised )
EURO AREA (15)
GERMANY
1.5
1.5
1
1
0.5
0.5
0
0
-0.5
-0.5
-1
-1
-1.5
-1.5
-2
-2
-2.5
-3
IPI
ORDER
EXP-prod
-2.5
-3.5
IPI
ORDER
EXP-prod
-3
Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09
Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09
FRANCE
ITALY
1
1.5
0.5
1
0.5
0
0
-0.5
-0.5
-1
-1
-1.5
-1.5
-2
-2
-2.5
-3
-2.5
IPI
ORDER
EXP-prod
-3.5
-3
IPI
ORDER
EXP-prod
-3.5
Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09
Ottawa, 27-29 May 2009
Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09
17
The quest for early
indicators of turning
points in economic
conditions …
Concluding remarks
Taking as reference the situation in Eu, the feasible improvements
(given current resources and statistical infrastructure) in
timeliness can play a small role in advancing the monitoring of the
business cycle and in particular in conveying advanced signals of
turning points of the cycle.
Moreover, in assessing the actual timeliness of an indicator its
characteristic volatility must be taken into account (small but
significant gains in the signal to noise ratio coming from adequate
filtering).
In turn, the information demand points at the well established
approach of Leading Economic Indicators that is probably time to
reconsider in the framework of OS.
Then in improving the set of ST indicators priority could be given
to the ones (to be identified empirically) with relevant leading
properties.
Finally, given the central role of survey data in anticipating BC
turning points it seems worthwhile investing in their quality,
possibly integrating them in the OS framework.
Ottawa, 27-29 May 2009
18