The ERIE Leading Index (ELI)

Transcription

1 The ERIE Leading Index (ELI) Presentation to Pennsylvania Economic Development Association October 2, 2018 James Kurre, Ph.D. & Kenneth Louie, Ph.D. The Economic Research Institute of Erie Sam and Irene Black School of Business Penn State Behrend

2 What is ERIE? An applied research unit of Penn State Behrend s Black School of Business: to collect, analyze, interpret, and disseminate information on the Erie economy to help the local community better understand the regional economy and its linkages to the national economy to serve as a reliable source of objective information for local leaders and media who have questions about the local, national, and international economies to promote outreach activities such as collaborative research projects with organizations and companies in the local community to give students experience in applied economic research and data analysis

3 ERIE Projects and Activities The ERIE Leading index (ELI) Clues to the direction of the local economy The annual ERIE Economic Conference Focuses on a specific theme each year The ERIE Guide to the Erie Economy Extensive statistics on the Erie economy ERIE Index of Entrepreneurship & Innovation Measures local E&I climate ERIE web site: ERIEdata.org

4 The ERIE Leading Index (ELI) ELI is a composite index, based on eight economic variables that track economic activity at the national, state, and local levels. ELI is intended to serve as a leading indicator, allowing us to identify the peaks and troughs of the local economy over the course of the business cycle in advance of those turning points. As such, ELI is an important tool that can help community leaders anticipate as well as prepare for changes in the direction of local economic activity.

5 ELI Issued Quarterly

6 Inside Each Issue

7 What s the Goal? To provide a tool that predicts the LOCAL (metro) economy. Help local businesses, governments, nonprofits and residents plan. To increase the visibility and reputation of ERIE locally. And maybe increase ERIE s income stream too! And TODAY to help you consider whether you might like to do something like this in your own area.

8 How Do We Measure the Local Economy? What data series do we actually forecast? Ideally: a comprehensive overall measure of the economy s performance Total production/output: Gross Metro Product Total income: Local Area Personal Income BUT the real world intrudes here! Look at: Availability of local data and its reliability Frequency of data Data lag

9 Our target series: local total employment Specifically: the BLS s Current Employment Statistics the establishment series or the payroll series Available monthly (crucial for business cycle forecasting) BLS has a stellar reputation Data lag is short Employment is correlated with output and income A widely-used standard and policy goal

10 Some Measure of the Economy Business Cycles Peak Peak Expansion Contraction or Recession Expansion Trough Trough Time

11 But the real world is messier

12 Turning Points U.S. turning points are determined by the Business Cycle Dating Committee of the National Bureau of Economic Research. Typically 6-18 months after the fact. - The committee does not judge in real time. -June 2009 trough was announced in Sep 2010, 15 mo. -Dec 2007 peak was announced in Dec 2008, 12 mo. -Nov 2001 trough was announced in July 2003, 20 mo.

13 Recession A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. The committee believes that domestic production and employment are the primary conceptual measures of economic activity. A cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions, and revivals which merge into the expansion phase of the next cycle; this sequence of changes is recurrent but not periodic; in duration business cycles vary from more than one year to ten or twelve years. -Business Cycle Dating Committee, NBER Arthur F. Burns and Wesley Clair Mitchell

14 Recession: one indicator

15 Jobs (in thousands) U.S. Business Cycles, , ,000 U.S. Total Employment 120, ,000 80,000 60,000 40,

16 Some Measure of the Economy Wouldn t It Be Nice If We had a data series that would turn up and down before the overall economy? Lead Time Time

17 Index (1/1960 = 100) Example: U.S. Residential Building Permits 230 U.S. Total Employment U.S. Building Permits

18 Index (1/1960 = 100) Hours per Week Example: U.S. Hours Worked per Week in Mfg <--U.S. Total Employment Hrs Worked, Mfg -->

19 The Conference Board s U.S. Leading Economic Index (LEI)

20 The Conference Board s U.S. Leading Economic Index Components of the U.S. Index of Leading Indicators Weights Leading credit index Average weekly hours, manufacturing Interest rate spread, 10-year Treasury bonds less federal funds rate Manufacturers' new orders, consumer goods and materials ISM new orders index Stock prices, 500 common stocks Average weekly initial claims for unemployment insurance Index of consumer expectations Building permits, new private housing units Manufacturers' new orders, non-defense capital goods Total Source: The Conference Board

21 Benefits of a Leading Indicator Approach to Forecasting Key alternative: econometric model of the economy Leading Indicator approach: Is simpler to create Requires much less data Is more intuitive, understandable by the public Provides info on turning points and timing, which other models often get wrong. BUT it does NOT give info on expected amount of change in variables; just says a change in the economy s direction is coming.

22 Can the U.S. LEI be a leading indicator for Erie? The U.S. economy tends to lead the Erie economy. But it doesn t always work that way. Erie Lead (-) or Lag (+) U.S. Index of Leading Indicators Peaks 1962M07 Missed 1966M M M M M M M M10 FALSE 1980M M12 Missed 1990M M M M M06 Missed 2007M M03 Avg Lead -13 Troughs 1963M07 Missed 1967M M M M M M01 FALSE 1980M M M M09 Missed 1991M M M M M06 Missed? 2009M03 Avg Lead -15

23 What about local effects on the economy? The local economy differs from the national economy. -industry mix (some tend to lead, others coincident, others lag.) -vintage of capital (older plants tend to be closed first.) -occupational mix (some occupations lead ) -demographics: -age (younger workers=less seniority/tenure, better tech skills?) -gender (men, women lead?)

24 So we need to create an ERIE Leading Index The goal is to create a more accurate leading index for the Erie economy. The main research was conducted by ERIE GRA Jeremiah Riethmiller under the guidance of Dr. James Kurre to determine which variables would best work for a local leading index.

25 How to Identify Candidate Leading Series? 1) Previous Work by Others -National, state, local leading indicators 2) Economic Theory - Logical leaders -How is the area different from the nation? -Location Quotients by industry -Which industries tend to lead nationally? -Occupations -Demographics 3) Brute Force -There are relatively few data series available, so try everything. 4) Settle for what we can get: If it works, use it!

26 Evaluating Candidate Series 1) Identify turning points in the target series (total employment) 2) Identify turning points in the candidate series 3) Compare: -missed turning points -false turns -length of the lead -consistency of the lead -volatility of the series 4) Consider performance at peaks vs. troughs

27 What are the data series which make up ELI? Components of ELI Weight U.S Interest Rate Spread U.S. Index of Coincident Indicators U.S. Real Money Supply (M2) PA Avg Weekly Hours in Manufacturing Erie Manufacturing Employment U.S. TS Freight Index S&P 500 Stock Index U.S. Building Permits Total 1.000

28 What variables were considered? Variables U.S. Index of Leading Indicators U.S. Passenger Index U.S. Index of Coincident Indicators PA Avg Weekly Hours in Manufacturing U.S. Total Employment Erie Avg Weekly Hours in Manufacturing U.S. Avg Weekly Initial Claims for Unemp Insurance* Erie Manufacturing Employment U.S. Housing Building Permits* Erie Construction Employment U.S. S&P 500 Stock Index* Erie Number of Residential Housing Permits U.S. Real Money Supply (M2)* Erie Residential Building Valuation U.S. Manufacturer's New Orders (Consumer Goods)* Erie Housing Prices U.S. Manufacturer's New Orders (Capital Goods)* Erie International Airport Enplanements U.S. Average Weekly Hours in Manufacturing* Erie International Airport Freight (lbs) Enplaned U.S. Vendor Performance Index* Erie Avg Weekly Initial Claims for Unemployment U.S. Interest Rate Spread* Erie Index of Local Help Wanted Ads U.S. Index of Consumer Expectations* Erie New Business Incorporations U.S. Freight Index Component of ELI * Components of U.S. Index of Leading Indicators

29 How are the weights for the ELI variables calculated? Series with greater volatility from month to month (higher standard deviations) would overwhelm changes in more stable series, so they are given lower weights. Weights for each series are calculated by taking the inverse of the standard deviations, the Conference Board s methodology for the national LEI. The weights are adjusted to sum to one in order to make the component series represent 100% of the index.

30 Time Frame Preliminary models were tested on data going back to 1962 Seven recessions The Transportation Services Freight Index starts in In our testing, we used a hybrid model: a 7-component index until 1990, then the current 8-component ELI. ELI was officially introduced at the ERIE Conference in August The current published version of ELI shows data back to 1990.

31 Index (2004 = 100) How successfully does ELI anticipate turns in Erie Total Employment? Erie Total Employment Erie Leading Index Erie Recessions ELI Turning Points Year Erie Employment ELI Lead (-) Time (months) Peaks 1974M M M M M M M M M M05 0 Avg Lead -8.4 Troughs 1976M M M M M M M M M M02 0 Avg Lead -6.6

32 Calling Turning Points in the Local Economy Dr. Barry Weller, Director Emeritus of ERIE, developed a turning point program, based on methodology developed by Bry & Boschan (1971). The turning point program does a good job identifying historical turning points in the Erie economy. However, it has its limitations with recent data because it does not identify a turning point within the last six data points of a series. To identify turning points as the data are collected, we found that a general rule of 5 consecutive months of decline or growth in the 3-month moving average of our model is likely to signal a turning point.

33 How is ELI calculated? At the end of every quarter, ERIE calculates ELI for the last 3 months. Data series are gathered from their respective sources and updated. Erie total employment, Erie manufacturing employment, and PA weekly hours in manufacturing are seasonally adjusted by ERIE using the Census x12 method. Next, the one month (percentage) change in each series is calculated. The weights are applied to the data by multiplying the calculated month-tomonth change in each series by its corresponding adjusted weight. The adjusted month-to-month changes are then summed across all series for each month to create a total one-month change series.

34 Things to Note About a Project Like This How will it be released to the community? Usually gets good media attention May get inquiries from community Sponsorship: pros and cons Very time-intensive

35 Thank You! James Kurre, Ph.D. Director Emeritus Ken Louie, Ph.D. Director (814)