Composite Leading Indicators: helping forecasters forecast

OECD Observer

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How reliable can economic forecasting be? It depends on several factors, like the quality of data and models, skill and judgement, etc. A key problem is anticipating turnarounds, those sometimes elusive points when rising growth begins to slow or when a downturn becomes an upswing. 

The OECD composite leading indicators (CLIs) are designed to provide early signals of turning points (peaks and troughs) between expansions and slowdowns of economic activity. CLIs are calculated by combining together component series that cover a wide range of key short-term economic indicators. These include observations or opinions about economic activity, housing permits granted, financial and monetary data, labour market statistics, information on production, stocks and orders, foreign trade, etc.

The component series selected are those known to provide an indication of future economic activity: building permits for instance are an indication of possible future construction, whereas unemployment, by contrast, is a lagging indicator in that it reflects decisions prompted by past economic activity. The number of component series used for the compilation of the OECD CLIs varies for each OECD country, but ranges between five and eleven series.

The OECD uses a 6-month rate of change for CLIs as its preferred pointer to possible turning points as this is less volatile and provides earlier, clearer signals for future turning points. As the graph shows, the CLI provides early signals for the turning points in total OECD economic activity. For example, a peak in the 6-month rate of change (annual rate) of the CLI for the total OECD occurred ten months (i.e. –10) before the actual peak in economic activity in December 1994. The CLI turned downwards in June-July 2002; however, two months of evidence is not sufficient to be able to use this drop as a forewarning of a downturn in economic activity.

CLIs provide an important aid for short-term forecasts (6-12 months) of changes in direction of the economy, and so help economists, businesses and policymakers to improve their analysis of current trends and anticipate economic developments. However, CLIs are one instrument of analysis and are no substitute for quantitative or long-term forecasts based on econometric models. They are designed to provide qualitative information so that judgements can be made on short-term economic movements, rather than providing quantitative measures.

The OECD CLIs are calculated for 22 member countries and seven aggregate geographical zones (total OECD area, G-7, NAFTA, OECD-Europe, European Union, Euro area and the Big Four European economies). The data are published monthly in Main Economic Indicators.

The latest CLI updates as well as further information on the compilation of OECD CLIs are available at www.oecd.org/std/cli or by e-mailing stat.contact@oecd.org. 

©OECD Observer No 234, Ocober 2002




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