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A new composite leading indicator of inflation for the UK: a Kalman filter approach

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  • Jane M. Binner
  • Stuart I. Wattam

Abstract

The principal objective of this paper is to develop a new approach to the construction of composite leading indicators using the signal extraction capabilities of the powerful Kalman filter. The resultant leading indicator properties are found to outperform those already derived using the Central Statistical Office methodology in the UK. A secondary aim of this paper is to compare the performance of the Divisia M4 monetary index with the standard Simple Sum measure of broad money in the context of composite leading indicators of inflation in the United Kingdom. The leading indicators proposed provide useful turning point information for inflation and indicators constructed using a Divisia index measure of money are found to be more closely related to the inflation reference cycle than indicators using their Simple Sum counterparts in all cases. Evidence presented here demonstrates the power of the Kalman filter as a robust signal extraction technique capable of producing the best parameter estimates over time. Further research into the development of Kalman filters for the construction of leading indicators is recommended.

Suggested Citation

  • Jane M. Binner & Stuart I. Wattam, 2003. "A new composite leading indicator of inflation for the UK: a Kalman filter approach," Global Business and Economics Review, Inderscience Enterprises Ltd, vol. 5(2), pages 242-264.
  • Handle: RePEc:ids:gbusec:v:5:y:2003:i:2:p:242-264
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    Citations

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    Cited by:

    1. J. M. Binner & R. K. Bissoondeeal & A. W. Mullineux, 2005. "A composite leading indicator of the inflation cycle for the Euro area," Applied Economics, Taylor & Francis Journals, vol. 37(11), pages 1257-1266.
    2. Alicia Gazely & Jane Binner & Graham Kendall, 2004. "Co-evolution vs. Neural Networks; An Evaluation of UK Risky Money," Computing in Economics and Finance 2004 258, Society for Computational Economics.
    3. Binner, J.M. & Tino, P. & Tepper, J. & Anderson, R. & Jones, B. & Kendall, G., 2010. "Does money matter in inflation forecasting?," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 389(21), pages 4793-4808.
    4. Seip, Knut Lehre & McNown, Robert, 2007. "The timing and accuracy of leading and lagging business cycle indicators: A new approach," International Journal of Forecasting, Elsevier, vol. 23(2), pages 277-287.
    5. Hao Tan & John A. Mathews, 2007. "Cyclical Dynamics in Three Industries," DRUID Working Papers 07-07, DRUID, Copenhagen Business School, Department of Industrial Economics and Strategy/Aalborg University, Department of Business Studies.

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