The Big Four Economic Indicators – What They’re Telling Us About the Economy
Guest post by Doug Short.
Official recession calls are the responsibility of the NBER Business Cycle Dating Committee, which is understandably vague about the specific indicators on which they base their decisions. This committee statement is about as close as they get to identifying their method.
There is, however, a general understanding that there are four big indicators that the committee weighs heavily in their cycle identification process. They are:
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The weight of these four in the decision process is sufficient rationale for the St. Louis FRED repository to feature a chart four-pack of these indicators along with the statement that “the charts plot four main economic indicators tracked by the NBER dating committee.” In his July 10th Bloomberg TV interview, ECRI’s Lakshman Achuthan cites these four at about the 2:05 minute point in his remarks. He says, and I quote “When you look at those four measures, they are rolling over.”
Are they really rolling over? First, here are the four as identified in the Federal Reserve Economic Data repository. See the data specifics in the linked PDF file with details on the calculation of two of the indicators.
The FRED charts are excellent. They show us the behavior of the big four indicators currently (the green line) as compared to their best, worst and average behavior across all the recessions in history for the four indicators (which have start dates). Their snapshots extend from 12 months before the June 2009 recession trough to the present.
The latest update to the Big Four was today’s release of the June Personal Income data, which included the annual revisions to past data back to January 2009. The chart below shows the new June data and the substantial revisions.
The revisions added a rather dramatic lift to the series and improved the upward trend in 2012. This indicator is certainly not, to use ECRI’s language, “rolling over.” Real Retail Sales is the one indicator that “could” be rolling over, but it is by far the most volatile of the four, so a dip in sales that is not confirmed by the other indicators has not historically been a reliable recession signal. We’ll have the next preliminary retail sales data in a couple of weeks.
See also this updated chart from Dwaine van Vuuren of RecessionAlert.com. It incorporates Dwaine’s preferred method of calculating the growth rate for Real Personal Income less Transfer Payments.
And here is his 5-Factor Weighted Composite, which includes a custom weighting of all four indicators.
Dwaine’s analysis now puts the implied probability of recession at 2.1%. For more on his analytical approach, see his The NBER co-incident Recession Model – “confirmation of last resort”.
Background Analysis: The Big Four Indicators and Recessions
The charts above don’t show us the individual behavior of the Big Four leading up to the 2007 recession. To achieve that goal, I’ve plotted the same data using a “percent off high” technique. In other words, I show successive new highs as zero and the cumulative percent declines of months that aren’t new highs. The advantage of this approach is that it helps us visualize declines more clearly and to compare the depth of declines for each indicator and across time (e.g., the short 2001 recession versus the Great Recession). Here is my own four-pack showing the indicators with this technique.
Now let’s examine the behavior of these indicators across time. The first chart below graphs the period from 1999 to the present, thereby showing us the behavior of the four indicators before and after the two most recent recessions. Rather than having four separate charts, I’ve created an overlay to help us evaluate the relative behavior of the indicators at the cycle peaks and troughs. (See my note below on recession boundaries).
The chart above is an excellent starting point for evaluating the relevance of the four indicators in the context of two very different recessions. In both cases, the bounce in Industrial Production matches the NBER trough while Employment and Personal Incomes lagged in their respective reversals.
As for the start of these two 21st century recessions, the indicator declines are less uniform in their behavior. We can see, however, that Employment and Personal Income were laggards in the declines.
Now let’s look at the 1972-1985 period, which included three recessions — the savage 16-month Oil Embargo recession of 1973-1975 and the double dip of 1980 and 1981-1982 (6-months and 16-months, respectively).
And finally, for sharp-eyed readers who can don’t mind squinting at a lot of data, here’s a cluttered chart from 1959 to the present. That is the earliest date for which all four indicators are available. The main lesson of this chart is the diverse patterns and volatility across time for these indicators. For example, retail sales and industrial production are far more volatile than employment and income.
Are the Big Four Rolling Over?
As of the latest data, no, they are not collectively rolling over. Here is the big picture since 1959, the same chart as the one above, but showing the average of the four rather than the individual indicators. This chart clearly illustrates the savagery of the last recession. It was much deeper than the closest contender in this timeframe, the 1973-1975 Oil Embargo recession. While we’ve yet to set new highs, the trend has collectively been ever upward.
The one outlier in recent months has been Real Retail Sales. As the next chart and table show, it has undergone a contraction in two of the past three months.
The decline in real retail sales is definitely a concern. A close study of the longer historical data shows that of the big four indicators, this one has tended to be a leader in the trend, although its higher volatility cautions us to take the current numbers with a grain of salt.