1 Revisions analysis of OECD composite leading indicators (CLI) Emmanuelle Guidetti Third Joint European Commission OECD Workshop on Business and Consumer Tendency Surveys

2 Introduction A leading indicator is a statistic that signals the movements, up and down, of future economic activity before they occur, and it may also give some indication of the magnitude of those movements. What is the purpose of the OECD CLI? How is the OECD CLI constructed? What is the current period performance of the CLI?

3 What is the purpose of the OECD CLI?

4 How is the OECD CLI constructed? Selection of Reference series Selection of components series PAT box (de-trending the series) Periodicity Transformation (monthly basis) Smoothing (reduce irregularity) Normalisation (cyclical amplitude homogenised) Weighting Aggregation into a single indicator (the minimum % of component series required is 60%) Presentation of CLI - Amplitude adjustment (refers to the deviation from the long-term trend of the series and focuses on the cyclical behaviour of the indicator) - Trend restoration (gives information about the likely rate and amplitude of changes) - Six months rate of change (is less volatile and provides earlier and clearer signals for future turning points than the CLI itself.)

5 What is the current performance of the CLI? The aim of the current analysis on CLIs is to evaluate the quality of the indicator when they are first released in order to: identify areas where their reliability could be improved provide further information to users on their use for economic analyses.

6 Why do we have revisions? Timeliness/availability Frequency Smoothness Other factors

7 Size of revisions Revision: R t =L t -P t

8 Size of revisions over time

9 Assessment of bias

10 Reliability of 1 st estimate as a signal of short- term expansion or slowdown in economic activity First measure is the sign of the movements around 90% of the time, for almost of the countries, the sign of the initial estimates of year-on-year growth rates are the same as those published one month later. This ratio becomes 95% while talking about zone aggregates. Second measure is the acceleration/deceleration test Around 80% of the time, for around 40% of the countries, the first estimate of year-on-year growth rates signals no difference in direction with the 2 nd estimates. This ratio becomes almost 90% while talking about zone aggregates.

11 Reliability of 1 st estimate to provide early signals of turning points in economic activity

12 Reliability of 1 st estimate to provide early signals of turning points in economic activity

13 Conclusion 1 st releases of CLI are revised frequently but the size is rather small for most countries and negligible for aggregates. No evidence of bias Improvement in the reliability of the 2 nd estimates 1 st and 2 nd estimates of year-on-year growth rates give reliable signals of approaching cyclical turning points It is not enough to have timely components they also need to be smooth to guarantee small revisions. This further reinforces the argument that smoothness is probably the most important factor explaining revisions to the OECD CLI.

14 Investigation on the importance of smoothness of the component series in the size of revisions of CLI Total components Survey componentsFinancial componentsOther components Response Rate of Surveys data Smoothness MCD ManufacturingConsumer Canada % Mexico % United States Australia % Japan % Austria %71% Belgium %100% Denmark %63% Finland %70% France %70% Germany %100% Ireland %57% Italy %100% Netherlands %70% Norway % Portugal %85% Spain %33% Sweden %100% Turkey United Kingdom % Total

15 Investigation on the importance of smoothness of the component series in the size of revisions of CLI Business or consumer tendency component with MCD of 4 or 5 or 6 MexicoIreland Finished goods stocks: tendencyFinished goods stocks : level Production: tendencyEmployment: tendency BelgiumOrder books: level Production: tendencyConsumer confidence Export order inflow: tendencyNetherlands DenmarkProduction: future tendency Consumer confidenceOrder inflow: tendency FinlandSpain Production: tendencyOrder books/demand: tendency GermanyTurkey Order inflow: tendencyProspects for exports United Kingdom Consumer confidence

16 Investigation on the importance of smoothness of the component series in the size of revisions of CLI The correlation coefficient between smoothness and mean absolute revision of first estimates of the CLIs is rather good and equals to The link is even stronger for second estimates of the CLIs with an extremely high correlation coefficient of The general pattern seems to be: the higher the MCD value the higher the mean absolute revision.

17 Investigation on the importance of smoothness of the component series in the size of revisions of CLI The revision analysis on Irish CLI components shows the following: R 2 =0.89

18 Investigation on the importance of smoothness of the component series in the size of revisions of CLI The revision analysis on German CLI components is: R 2 =0. 94

19 Investigation on the importance of smoothness of the component series in the size of revisions of CLI If we plot together Irish and German results we can get the following graph: R 2 =0. 85

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