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leading indicators

Index of Leading Indicators

The Index of Leading Indicators is an American economic index intended to estimate future economic activity. It is calculated by The Conference Board, a non-governmental organization, which determines the value of the index from the values of ten key variables. These variables have historically turned downward before a recession and upward before an expansion. The single index value composed from these ten variables has generally proved capable of predicting recessions over the past 50 years. Those who have an activist view believe in discretionary monetary and fiscal policy. They believe that the index of leading indicators can provide an early warning system so that policymakers can shift toward macroeconomic stimulus when the index fails.

One problem with the index of leading indicators is that the time lag between the signal of a recession and the actual recession has varied widely. Also, on a few occasions, the index of leading indicators has fallen, and no recession occurred. That is, the index has given a few false alarms. Hence, policymakers must react carefully to the changes in the index.

The 10 components of the Index include:

  1. Average number of initial applications for unemployment insurance
  2. Number of manufacturers' new orders for consumer goods and materials
  3. Speed of delivery of new merchandise to vendors from suppliers
  4. Amount of new orders for capital goods unrelated to defense
  5. Amount of new building permits for residential buildings
  6. The S&P 500 stock index
  7. Inflation-adjusted monetary supply (M2)
  8. Spread between long and short interest rates (the yield curve)
  9. Consumer sentiment
  10. Average weekly hours worked by manufacturing workers

While this index correctly forecast each of the 7 recessions during the 1959-2001 period it also has forecast 5 recessions that did not occur.

This naturally brings to mind a famous saying by economist Paul Samuelson: "Economists have correctly predicted nine of the last five recessions."

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