Finance & economics | Forecasting the present

Taking the economic pulse

How to gauge the current state of the economy

IT IS hard to predict the future: witness forecasters’ failure to foresee the financial crisis. Indeed, even ascertaining the current state of the economy is tricky. The first official estimates of quarterly GDP are generally published between four and six weeks after each quarter has finished. Interpreting them can be fraught since they are frequently revised. Such delays and uncertainties have led economy-watchers to search for other gauges.

Simply asking business-folk what they think is a venerable tradition—Britain’s Industrial Trends for example dates back to 1958—but such surveys are flourishing as never before. Among the most influential are purchasing-manager indices (PMIs). Every month managers in both manufacturing and private services are asked whether their firms’ output, employment, orders and the like have expanded or contracted (compared with the previous month). An index based on the net balance of their answers shows expansion above the level of 50 and contraction below it.

These findings can in turn be used to estimate the current rate of growth, given the previous relationship between the indices and GDP. For example, Markit, a research group, reported this week that their composite index for manufacturing and services in the euro zone stood at 52.8 in June. The survey suggests the euro area should grow by around 0.4% in the second quarter, twice as fast as in the first, says Chris Williamson, an economist at Markit.

Markit’s estimate of second quarter euro-zone GDP growth appeared six weeks before the first official estimate. Such surveys have other benefits: the method is transparent and easy to grasp. And the findings are not revised once the final reports emerge a week after the “flash” estimates.

Some data providers go further, seeking to exploit all relevant statistics, such as official figures for new passenger-car registrations. This requires a sophisticated model to extract a common signal for GDP from the welter of data that become available. This is the approach adopted by Now-Casting Economics, a firm whose founders include two economists, Lucrezia Reichlin and Domenico Giannone. In the case of the euro zone, their model gobbles up 50 monthly variables and uses their past relationships with GDP to calculate an estimate for the current quarter. At present the firm, whose clients are hedge funds and other asset managers, is expecting growth of 0.26% in the second quarter—somewhat more sluggish than Markit’s estimate.

In principle, the model-based approach might appear superior because it exploits more information. On the other hand, it is more of a black box. Since surveys are themselves an important source of information for the nowcasts this suggests that the two methods will co-exist.

This article appeared in the Finance & economics section of the print edition under the headline "Taking the economic pulse"

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