The Use of the Composite Leading Index for Forecasting Business Cycle Turning Points

1. Introduction At the quarterly frequency, GDP is regarded as the most important single economic series representing the state of the economy. However, at monthly frequency, there is no single economic series which can cover the overall activities of the economy. The Conference Board's Composite Index of Coincident Indicators (CCI), a composite index of employment, income, output and sales, is designed to trace the state of the economy at the monthly frequency. Peaks and troughs in CCI are very close to the official peak and trough dates from the National Bureau of Economic Research. It provides timely information about current economic conditions and is also highly correlated with GDP with raw correlation 0.99. The Conference Board's Composite Index of Leading Indicators (CLI) is widely used to gauge the direction of the future path of the economy and forecast future business cycle turning points. The record of the CLI is less consistent. The average lead time for the peaks and troughs is nine and half months and four and half months, respectively. The standard deviations associated with the lead time of CLI are four and half months for the peaks and two and half months for the troughs. In general, sustained declines in the CLI are required in order to signal potential future downturns of the economy. However, there is no specific rule about how large the declines should be. A simple rule of thumb is to consider three-month consecutive declines in the leading index as a signal of a forthcoming recession. But this criterion alone is not sufficient to distinguish between slowdown and recession. And it often gives false signals. Other rules may perform better than this simple rule. A more sophisticated approach is to examine " The Three Ds " : the duration, depth, and diffusion of the leading indicators. The longer the weakness continues, the deeper it gets, and the more widespread it becomes, the more likely a recession will occur. This approach incorporates the important features of business