Tuesday, January 31, 2012

Econometricians Exposed Big Time

Ed Yardeni tells is like it is about the snake oil mathematicians:
I’m not a big fan of leading economic indexes (LEIs). They can be quite misleading. They are constructed by well-intentioned economists with the intention of providing an early warning that a recession is coming in a few months or assurance that the economy is likely to expand in coming months. These man-made indexes combine a bunch of indicators that purportedly lead the business cycle. When they fail to do so, the men and women who made these indexes recall them, retool them, and send them back out for all of us to marvel at how well these new improved versions would have worked in the past. I can accurately predict that when they fail in the future, they will be recalled and redesigned yet again.

This just happened to the US LEI. The Conference Board has made the first major overhaul of the components of the LEI since it assumed responsibility of the index in 1996. It replaced real money supply with its proprietary leading credit index, and the ISM supplier delivery index with the new orders index. In place of the Thomson Reuters/University of Michigan consumer expectations measure, it will now use an equally weighted average of its own consumer expectations index and the current measure. Also, the nondefense capital goods gauge was tweaked to exclude commercial aircraft.

The impact of these changes has been shocking, and really questions the credibility of constructing LEIs. The old LEI rose to a new record high in November, exceeding the previous cyclical peak (where it hovered during 2006 and 2007) by 12.7%. The new LEI edged back up in December to its previous high for the year during July, but that’s 13.1% below the previous cyclical peak!
What about the ECRI Weekly LEI? It tended to track both the old and the new monthly LEIs prior to 2009. Since then, they’ve all diverged though the weekly index is now more in sync with the new one than the old one. Still, the weekly LEI has been very volatile and gave a misleading warning of a recession during both 2010 and 2011 (so far)

1 comment:

  1. If the economic indicator were so much trust worthy, the current financial crisis must have been averted. There was no alert in 2007 about such crises but is there and a recession may be in offing. These indices are nothing but some inventions that are aimed to serve specific causes not for the whole economy.