The 2001 Recession and the Chicago Fed National Activity Index: Identifying Business Cycle Turning points.(Federal Reserve Bank of Chicago Rekeases the Chicago Fed National Activity Index)(Statistical Data Included)

Abstract

Introduction and summary On March 5, 2001, the Federal Reserve Bank of Chicago first released publicly the Chicago Fed National Activity Index (CFNAI), a single, summary measure of real economic activity that is based on a weighted average of 85 economic indicators. This inaugural CFNAI release explicitly mentioned the possibility that the U.S. economy had begun to slip into a recession. On November 26, 2001, the National Bureau of Economic Research's (NBER) Business Cycle Dating Committee that a peak in business activity had in fact occurred in the U.S. economy in March 2001 (NBER, 2001). As the eight-months lag of the NBER report indicates, business cycle turning points are typically only recognized many months after the event; thus, the ability of the CFNAI to identify the recession in approximately real time is important--since early recognition of business cycle turning points will enable more timely monetary policy responses. Although one of the first uses of the CFNAI was to gauge inflationary pressures (Fisher, 2000), there is a strong statistical relationship between this index of economic activity and business cycle movements. We can see this in figure 1, which displays the three-month moving average index (CFNAI-MA3) from 1986 through 2001. Whenever the three-month moving average of this index falls into the range of -0.70 to -1.00, there is an increasing probability that the U.S. economy is in a recession. The substantial fall in the index to -1.50 in late 1990 corresponds to the 1990-91 recession. Similarly, the 2001 recession (see figures 2 and 3) is clearly evident as the index fell below -1.00. Prior to the current recession, there were five recessions over the 1967-2000 period. In six cases, the CFNAI-MA3 fell below -0.70, after having previously been above zero when the economy was expanding. On five of these occasions, the U.S. economy had just entered a recession as determined later by the NBER. Taken at face value, this is an 83 percent success rate for the CFNAI. To further our understanding of the CFNAI and its role as a business cycle indicator, we address two main questions in this article. First, what is the general relationship between the CFNAI and economic recessions? While economic downturns are clearly evident in the sharp reductions in the CFNAI, how much more information do we gain beyond what we would learn by simply focusing on single indicator measures of economic activity like industrial production, personal consumption expenditures, and others? We offer a graphical analysis of the data to answer this question. Second, what probabilistic statements about economic performance can we attach to specific values of the CFNAI-MA3? When the CFNAI-MA3 plunges to values below -0.70, what is the probability that the U.S. economy has entered a recession? We adopt a statistical approach to modeling the dynamic evolution of the 85 economic indicators in order to answer this question. To summarize our findings, our graphical analysis indicates that individual economic indicators appear to predict the onset of economic recessions almost as well as the CFNAI-MA3. Indeed, many business cycle analysts prefer a relatively small number of economic indicators to guide their analysis. For example, the NBER November 2001 committee report makes clear the importance of four monthly coincident economic indicators of real activity: payroll employment, industrial production, real personal income less transfer payments, and manufacturing and trade sales in real terms. (1) However, while all of the economic indicators were signaling that the real economy was growing well below trend throughout this period, they conveyed different information about the timing of the business cycle peak. Essentially, the NBER selected the business peak based upon a peak in one very important indicator, total payroll employment. Visual inspection of the co-movements between industrial production, employment, and the CFNAI-MA 3 suggests that perhaps the gain in computing the index of 85 indicators is fairly small. …