Working Papers 2001 – Abstracts

The Missing Link: Using the NBER Recession Indicator to Construct Coincident and Leading Indices of Economic Activity

João Victor Issler and Farshid Vahid

We use the information content in the decision of the NBER Business Cycle Dating Committee to construct coincident and leading indices of economic activity for the United States. Although several authors have devised sophisticated coincident indices with the ultimate goal of matching NBER recession, no one has used past information on NBER recessions to construct a coincident index. A second ingredient of our method is that we only use the cyclical part of the coincident series to explain the NBER recession indicator. Specifically, we use canonical correlation analysis to filter out the noisy information contained in the coincident series. Finally, to construct our preferred coincident index of the U.S. business cycle, we take account of measurement error in the commonly used coincident series by using instrumental-variable methods. The resulting index is a simple linear combination of four coincident series that encompassed currently popular coincident indices.

Keywords: Coincident and Leading Indicators, Business Cycle, Canonical Correlation, Instrumental Variable Probit, Encompassing.

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