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A Probability Model of The Coincident Economic Indicators

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  • James H. Stock
  • Mark W. Watson

Abstract

The Index of Coincident Economic Indicators, currently compiled by the U.S. Department of Commerce, is designed to measure the state of overall economic activity. The index is constructed as a weighted average of four key macroeconomic time series, where the weights are obtained using rules that dare to the early days of business cycle analysis. This paper presents an explicit rime series model (formally, a dynamic factor analysis or "single index" model) that implicitly defines a variable that can be thought of as the overall state of the economy. Upon estimating this model using data from 1959-1987, the estimate of this unobserved variable is found to be highly correlated with the official Commerce Department series, particularly over business cycle horizons. Thus this model provides a formal rationalization for the traditional methodology used to develop the Coincident Index. Initial exploratory exercises indicate that traditional leading variables can prove useful in forecasting the short-run growth in this series.

Suggested Citation

  • James H. Stock & Mark W. Watson, 1988. "A Probability Model of The Coincident Economic Indicators," NBER Working Papers 2772, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:2772
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    References listed on IDEAS

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    1. Diebold, Francis X & Rudebusch, Glenn D, 1989. "Scoring the Leading Indicators," The Journal of Business, University of Chicago Press, vol. 62(3), pages 369-391, July.
    2. repec:adr:anecst:y:1987:i:6-7:p:12 is not listed on IDEAS
    3. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-384, March.
    4. repec:adr:anecst:y:1987:i:6-7 is not listed on IDEAS
    5. Beatrice N. Vaccara & Victor Zarnowitz, 1978. "Forecasting with the Index of Leading Indicators," NBER Working Papers 0244, National Bureau of Economic Research, Inc.
    6. Kling, John L, 1987. "Predicting the Turning Points of Business and Economic Time Series," The Journal of Business, University of Chicago Press, vol. 60(2), pages 201-238, April.
    7. Engle, Robert & Granger, Clive, 2015. "Co-integration and error correction: Representation, estimation, and testing," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 39(3), pages 106-135.
    8. Auerbach, Alan J, 1982. "The Index of Leading Indicators: "Measurement without Theory," Thirty-Five Years Later," The Review of Economics and Statistics, MIT Press, vol. 64(4), pages 589-595, November.
    9. Friedman, Benjamin M, 1988. "Monetary Policy without Quantity Variables," American Economic Review, American Economic Association, vol. 78(2), pages 440-445, May.
    10. Thomas J. Sargent & Christopher A. Sims, 1977. "Business cycle modeling without pretending to have too much a priori economic theory," Working Papers 55, Federal Reserve Bank of Minneapolis.
    11. James H. Stock & Mark W. Watson, 2001. "Vector Autoregressions," Journal of Economic Perspectives, American Economic Association, vol. 15(4), pages 101-115, Fall.
    12. Koch, Paul D & Rasche, Robert H, 1988. "An Examination of the Commerce Department Leading-Indicator Approach," Journal of Business & Economic Statistics, American Statistical Association, vol. 6(2), pages 167-187, April.
    13. F. Javier Fernandez Macho & Andrew C. Harvey & James H. Stock, 1987. "Forecasting and Interpolation Using Vector Autoregressions with Common Trends," Annals of Economics and Statistics, GENES, issue 6-7, pages 279-287.
    14. Nelson, Charles R. & Plosser, Charles I., 1982. "Trends and random walks in macroeconmic time series : Some evidence and implications," Journal of Monetary Economics, Elsevier, vol. 10(2), pages 139-162.
    15. Neftici, Salih N., 1982. "Optimal prediction of cyclical downturns," Journal of Economic Dynamics and Control, Elsevier, vol. 4(1), pages 225-241, November.
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