In the ongoing effort to utilize and improve the forecasting properties of leading indicators, analysts on both sides of the Atlantic and Pacific are increasingly combining quantitative indicators of the sort pioneered by Arthur F. Burns and Wesley C. Mitchell with qualitative survey data. We have in the past considered the forecasting usefulness of a number of surveys, including the surveys conducted by the European Economic Community, the Confederation of British Industry in the United Kingdom, Dun and Bradstreet, Inc., and the Michigan Survey Research Center in the United States. In a paper we presented at the September 1985 meeting of CIRET in Vienna, we explored some of the forecasting properties of the price surveys conducted by the National Association of Purchasing Management (NAPM) in the United States (Moore and Klein, 1985). One of the unique features of this survey is that it reports buying prices rather than selling prices, and we examined some of the relationships between this survey and measures of price fluctuations.

The preliminary work with the NAPM data proved so promising that we here concentrate on this source and develop the analysis not only of prices but also of other leading indicators, namely, new orders, inventory change, and vendor performance. In each case we shall compare the turning points in the NAPM series with the U.S. business cycle chronology as well as with comparable quantitative series. Correlation analyses will also be used. In this way we can evaluate the overall usefulness for forecasting of a data set that we believe has been underutilized thus far.

Long-leading versus short-leading indicators

Most of the leading indicators that have been in use for many years have relatively short leads, averaging about six or eight months at business cycle peaks, when recessions begin, and two to four months at troughs, when recoveries start. Since there are often delays of a month or so in reporting the figures, and even longer delays in judging whether a turn in an indicator is significant, a recession or recovery may be well under way before it can be recognized. One way to deal with this problem is to distinguish indicators with exceptionally long leads from others.

The new long-leading index currently published by the Center for International Business Cycle Research takes a step in this direction. Using the revised list of fifteen leading indicators (Moore, 1989), we classified as long-leading those that had average leads of at least twelve months at peaks and six months at troughs during 1948–82. The four indicators that qualified as long-leading were bond prices, real money supply (M2), new building permits for housing, and a profit margin indicator, the ratio of prices to unit labor costs in manufacturing. A longleading index constructed from these series is shown in Figure 8.1, together with the short-leading index based on the other eleven series. Also shown is the Department of Commerce leading index as revised in March 1989, which contains two of the series in our long-leading group (money supply and housing permits), seven series in our short-leading group, and two other series.

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:

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.

The immediate origin of this book was a conference held at the State University of New York at Albany in May 1987 at which a number of well-known exponents of leading indicators research were invited to offer their views on this subject. During the conference the need was felt for a volume that would systematically explain and evaluate the old and the new emerging techniques dealing with leading economic indicators. Thus, the volume is not the proceedings of the conference, but rather a collection of mostly previously unpublished articles broadly representing current research in this field. A number of authors were commissioned to write chapters on specific topics, and the two editors undertook to provide an appropriate framework. Many of the economists whose work has been central to the development of leading indicators report new research, review progress in specific areas, and discuss directions for further work. We hope that the book will prove useful to university economists and students interested in business cycles and forecasting, as well as to those in business firms, government agencies, and international organizations who wish to keep abreast of new developments in this field and adapt them for practical use.

The editors are grateful to the authors for their contributions, their involvement in revising their own chapters, and their patience during the course of the production of the book.

The Gramm-Rudman-Hollings (GRH) law passed by the Congress in December 1985 establishes a process whereby the Federal budget deficits are to be gradually phased out by the fiscal year (FY) 1991. A series of targeted ceilings on the unified budget deficit is instituted, beginning with $172 billion for FY 1986 and $144 billion for FY 1987 and proceeding by decrements of $36 billion per year to zero in FY 1991. The planned reductions are to be achieved by spending and tax measures agreed upon by the legislative and executive branches of the U.S. government. However, if an agreement is not reached, the target for any FY is to be achieved through an automatic across-the-board spending cut in all eligible defense and nondefense categories. Early in 1986 a lower court ruled that the sequestering provision of GRH is unconstitutional; this ruling was confirmed by the Supreme Court on July 7, 1986. This does not pertain to the issues discussed in this paper.

Section 254 of the GRH law provides for “Special Procedures in the Event of a Recession.” It states that the Congressional Budget Office (CBO) Director shall notify the Congress at any time (a) if the CBO or the Office of Management and Budget (OMB) “as determined that real economic growth is projected or estimated to be less than zero with respect to each of any two consecutive quarters” within a period of six successive quarters starting with the one preceding such notification, or (b) “if the Department of Commerce preliminary report of actual real economic growth (or any subsequent revision thereof) indicates that the rate of real economic growth for each of the most recent reported quarter and the immediately preceding quarter is less than one percent.”