Published online by Cambridge University Press: 05 June 2012
The leading indicator approach
The leading indicator approach to economic and business forecasting is based on the view that market-oriented economies experience business cycles within which repetitive sequences occur and that these sequences underlie the generation of the business cycle itself. Wesley Mitchell (1927), one of the founders of the National Bureau of Economic Research (NBER), first established a workable definition of business cycles, and Burns and Mitchell (1946) rephrased it as follows:
Business cycles are a type of fluctuation found in the aggregate economic activity of nations that organize their work mainly in business enterprises: a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions and revivals that 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 a year to ten or twelve years; they are not divisible into shorter cycles of similar character with amplitudes approximating their own.
The leading economic indicator (LEI) approach then is to find the repetitive sequences, to explain them, and to use them to identify and to forecast emerging stages of the current business cycle.
The approach differs from the usual econometric model, which does not differentiate business cycles from other economic fluctuations, except perhaps seasonal variation.