Real-Time Macroeconomic Monitoring

Francis X. DieboldUniversity of Pennsylvania

April 28, 2014

1 / 28

Economic and Financial Decision Making Over the Cycle

I Merger activity over the cycle

I Pricing and other competitive issues over the cycle

I Accounting behavior over the cycle

I Distress and bankruptcy over the cycle

I Labor/personnel decisions over the cycle

I Portfolio allocation over the cycle

I Risk management over the cycle

I Asset pricing over the cycle

2 / 28

Our Approach

I Guide real people, making real decisions, in real time

I Nowcasting, updated in real-time

We want:

I Real-time information (inputs and output)

I Based on many indicators

I Quantitative (cardinal), not 0-1 (ordinal)

3 / 28

Real-Time Interest is Percolating

I Conferences

I Centers

I Handbook chapters

I Policy

4 / 28

Several Authors/Papers/Teams...

Aruoba, Diebold and Scotti(2009, J. Bus. and Econ. Stats.)“Real-Time Measurement of Business Conditions”

Aruoba, Diebold, et al.(2009-present, FRB Phila. RTDRC)“Real-Time ADS Index” (website)

Aruoba and Diebold (2010,American Economic Review)“Real-Time Macroeconomic Monitoring”

Aruoba, Diebold, Kose and Terrones (2011 National Bureau ofEconomic Research)“Globalization, the Business Cycle, and Macro Monitoring”

5 / 28

Underlying High-Frequency Dynamic Factor Structure

Economic activity factor:

xt = φxt−1 + ηt

i th indicator:

y it = c i + βixt + εit

(Close Cousin: Stock and Watson, 1989)

6 / 28

Methodological Econometric Issues

I High-frequency, mixed-frequency, missing data(Close cousin: Mariano and Murasawa, 2003)

I Time-varying system matrices

I Modified filtering and likelihood evaluation

I Optimal extraction of latent macroeconomic activity

7 / 28

State Space Representation

yt = Zαt + εt

αt+1 = Tαt + Rηt

εt ∼ (0,H) , ηt ∼ (0,Q)

8 / 28

Kalman Filter Extraction of Latent Economic Activity

at|t = at + PtZ′F−1t vt

Pt|t = Pt − PtZ′F−1t ZP ′t

at+1 = Tat|t

Pt+1 = TPt|tT′ + RQR ′

where

vt = yt − Zat

Ft = ZPtZ′ + H

at|t ≡ E (αt |Yt), Pt|t = var (αt |Yt), at ≡ E (αt |Yt−1),Pt = var (αt |Yt−1), Yt ≡ {y1, ..., yt}

9 / 28

Filtering with Missing Data

All of yt missing (skip updating):

at+1 = Tat

Pt+1 = TPtT′ + RQR

Some of yt missing (update w/ modified measurement eqn.):

y∗t = Z ∗αt + ε∗t

ε∗t ∼ N (0,H∗)

y∗t = Wtyt , Z∗ = WtZ , ε

∗t = Wtεt , H

∗ = WtHW′t

10 / 28

Likelihood Evaluation with Missing Data

ln L =T∑t=1

ln lt

where:

ln lt = 0, if no elements of yt are observed

ln lt = −12

(N∗ log 2π +

(log |F ∗t |+ v∗′t F ∗−1t v∗t

)), otherwise

11 / 28

Substantive Macroeconomic Issues

I What indicators, at what frequencies?

I How has real activity behaved historically?

I What happened to real activity during the Great Crisis of2007-2009?

I Where is the economy now?

I What about inflation?

I What about the global economy?

12 / 28

Real Activity

I [ Initial unemployment claims (weekly) ]

I Payroll employment (monthly)

I Industrial production (monthly)

I Personal income less transfers (monthly)

I Manufacturing and trade sales (monthly)

I GDP (quarterly)

13 / 28

-8

-6

-4

-2

0

2

4

6

60 65 70 75 80 85 90 95 00 05

Real Activity Index

I Coherence with NBERI Less noisy than individual indicatorsI “Great Moderation”I Recent episode

14 / 28

-6

-4

-2

0

2

4

1973 1974 1975

1973-1975 Recession

-6

-4

-2

0

2

4

1979 1980 1981

1980 Recession

-6

-4

-2

0

2

4

1981 1982 1983

1981-1982 Recession

-6

-4

-2

0

2

4

1990 1991 1992

1990-1991 Recession

-6

-4

-2

0

2

4

2000 2001 2002

2001 Recession

-6

-4

-2

0

2

4

2007 2008 2009

2007-2009 Recession

Real Activity Index During Recessions

15 / 28

2007-2009: Moderately Extreme Depth Severity

1

2

3

4

5

6

7

Recession Depth Severity

60-61 69-70 73-75 80 81-82 90-91 01 07-09

16 / 28

2007-2009: Extreme Duration Severity

4

6

8

10

12

14

16

18

20

Recession Duration Severity

60-61 69-70 73-75 80 81-82 90-91 01 07-09

17 / 28

2007-2009: Highly Extreme Overall Severity

10

15

20

25

30

35

40

45

50

Overall Recession Severity

60-61 69-70 73-75 80 81-82 90-91 01 07-09

18 / 28

Real-time real activity index updates at:

Federal Reserve Bank of Philadelphia

19 / 28

Inflation

I All items CPI (monthly)

I Finished goods PPI (monthly)

I Standard and Poor’s GSCI Non-Energy Commodities Index(monthly)

I Spot price of West Texas intermediate crude oil (monthly)

I Hourly compensation in the non-farm business sector(quarterly)

I GDP deflator (quarterly)

20 / 28

-8

-6

-4

-2

0

2

4

6

8

60 65 70 75 80 85 90 95 00 05

Inflation Index

I Great inflation, Volcker containment

I Increased volatility post-2000

I Recent episode

21 / 28

-8

-6

-4

-2

0

2

4

07M01 07M07 08M01 08M07 09M01 09M07

Inflation Index, 2007-2009

22 / 28

Real Activity and Inflation Interaction

I Demand shocks: Real activity and inflation positivelycorrelated

I Supply shocks: Real activity and inflation negatively correlated

23 / 28

-8

-6

-4

-2

0

2

4

6

-8

-4

0

4

8

60 65 70 75 80 85 90 95 00 05

Real Activity and Inflation Indexes

Inflation

RealActivity

I Usually positively correlated

I Negatively correlated during oil shocks

I Recent episode

24 / 28

-6

-4

-2

0

2

-8

-6

-4

-2

0

2

4

07M01 07M07 08M01 08M07 09M01 09M07

Real Activity and Inflation Indexes, 2007-2009

Inflation

RealActivity

I Positive correlation

I A Keynesian demand-driven recession

25 / 28

Going Global: An Extracted G-7 Factor

-5

-4

-3

-2

-1

0

1

2

3

1970 1975 1980 1985 1990 1995 2000 2005

26 / 28

Comparative Behavior of Country Factorsin Two Recessions

-5

-4

-3

-2

-1

0

1

2

3

4

I II III IV I II III IV I II III IV

1973 1974 1975

Country Factors around 1974

-6

-5

-4

-3

-2

-1

0

1

I II III IV I II III IV I II III IV

2007 2008 2009

U.S. U.K. Canada

Japan France Germany

Italy

Country Factors around 2008

27 / 28

Concluding Remarks

This time was not different, but it was certainly severe.

Extensions include:

I Higher-frequency component indicators

I Richer component indicators (e.g., GDPE and GDPI )

28 / 28