Worcester Economic Indicators – Summary of Methods

There are three components to this project:

  1. The Worcester Economic Index. An index of the recent performance of the greater Worcester economy based on local employment data.
  2. A growth forecast for the Worcester Economic Index over the coming 3-6 months which is estimated using a set of national leading indicators.
  3. A diffusion index of local leading indicators.

Worcester Economic Index

The Worcester Economic Index (WEI) utilizes the methodology introduced by Stock & Watson (1989) and utilized by Clayton-Matthews & Stock (1998/99), Crone & Clayton-Matthews (2005), and Tebaldi and Kelly (2012) to estimate an index of an underlying economy. Unlike the national economy where a broad measure of economic activity (GDP) is reported on a timely basis, state and local economic performance data such as personal income or local GDP are reported with substantial lag times. In order to fill in the gaps, the above authors have demonstrated how an index of the underlying economy can be estimated for a dynamic single-factor model using the Kalman filter. Stock & Watson (1989) applied the methodology to the national economy, while Clayton-Matthews & Stock (1998/99), Crone & Clayton-Matthews (2005), and Tebaldi and Kelly (2012) estimated state indexes. The use of this methodology to estimate an index of the Worcester economy is one of the first at the sub-state level. By relying on local employment and unemployment data that is released monthly by the Bureau of Labor Statistics , an index of local economic performance is found that is more current than local personal income or local contribution to GDP that are reported by the Bureau of Economic Analysis.

The Worcester Economic Index is based on the movements of three employment variables for the Worcester area: total nonfarm payroll employment, total household employment, and the unemployment rate. Total nonfarm payroll employment is available from the Bureau of Labor Statistics (BLS) on a monthly basis and is based on the Current Employment Statistics Survey of business establishments. Total household employment and the unemployment rate are both products of the Local Area Unemployment Statistics program of the BLS, which is based on the Current Population Survey of households. All three variables are available for the Worcester NECTA which includes 37 cities and towns in south central Massachusetts, as well as 3 northeastern Connecticut towns. The BLS provides seasonally adjusted data for total payroll employment, while total household employment and the unemployment rate are only available on a not seasonally adjusted basis. Therefore household employment and the unemployment rate are seasonally adjusted each month using the X-12 ARIMA program available from the U.S. Census Bureau.

These three employment variables are used to estimate changes in the Worcester economy utilizing the Stock/Watson methodology. The resulting index is not just an average of each of the three variables, but is an estimate of path of the economy that would be most consistent with the changes in the employment variables.

SummaryFigure1The diagram on the right shows the month-to-month changes in the three observable variables and the estimated change in the underlying economy. Note that the rate of change of the index is less volatile than the observed variables. This is desirable because the economy does not bounce around monthly but changes more gradually. The Stock/Watson methodology provides an estimate of the growth in the index that is smoother than the underlying monthly data. This is due to the use of the Kalman filter which utilizes not just current data but past data as well to estimate the index of economic activity for a particular month. Employment and unemployment variables at the local level are quite volatile because the Bureau of Labor Statistics estimates are based on a smaller sample size than the national estimates. By taking into account data from multiple months the fluctuations in the underlying index that may result from sampling error are reduced.

The WEI is estimated each month after new data on employment and unemployment for the Worcester region becomes available from the Bureau of Labor Statistics.

Estimating the Growth of the Worcester Economic Index

After the Worcester Economic Index is estimated the next step is to forecast its future path. In order to do this the observed six-month growth rate of the WEI is calculated for all past periods. Then, regression analysis is used to estimate an equation that explains the growth rate as a function of recent changes in the WEI and four leading indicators: S&P 500, Leading Credit IndexTM, interest rate spread, and consumer expectations. These leading indicators were chosen from a longer list because they seemed to offer the best predictions of future growth in WEI. Each month, after the WEI is estimated, a growth rate forecast is found using the most up to date values of the leading indicators. The resulting forecast can be disaggregated into the components that contribute to the forecast.

A Diffusion Index of Local Leading Indicators

In order to provide additional information about the Worcester economy several other leading indicators are considered. Unlike the nationally based indicators used to forecast growth in the WEI, these indicators are all based on local information. The four data series that are available at the local level are: initial unemployment claims, new business incorporations, online help-wanted advertising (HWOLTM), and new building permits issued (value). Each of these variables may provide leading information on the direction of the local economy. In order to summarize the changes in these leading indicators a diffusion index is calculated.

Following the procedure used by The Conference Board , a diffusion index is found by first calculating the percentage change for each component in the index over the relevant time frame in this case six months. Next, components which increase more that 0.05% are given a value of 1, components that decreases more than 0.05% are given a value of zero, and components that basically unchanged (between -0.05% and +0.05%) are given a value of 0.5. The values are then summed and the total is divided by the number of components. If all of the indicators are unchanged the resulting diffusion index will be 50, therefore an index above 50 says that a majority of the indicators have been increasing and is a positive signal for future economic conditions. Conversely, and index below 50 shows the leading indicators are on balance declining and signal an economic downturn.

The four indicators used to estimate the diffusion index are the best available leading indicators for the local area. The first local leading indicator is initial unemployment claims for the Worcester region, an increase in which signals a drop off in economic activity. The second indicator is the amount of online help-wanted advertising for the Worcester area . An increase in help-wanted ads should be a precursor to increased hiring and employment. The third leading indicator is the number of new business incorporations in the local area . An increase in incorporations may lead new hiring by those firms. Finally, since building permits are required before new residential construction can take place, an increase in building permits would foreshadow increases in future employment. In comparison with national level data, local data can be quite volatile and therefore short-term changes in any variable or the diffusion index as a whole should considered with caution. Only when the diffusion index is above or below 50 for at least three months should it be considered a signal of future economic activity.

Prepared by:

Thomas White, Ph.D.
Department of Economics & Global Studies
Assumption College
508-767-7556
twhite@assumption.edu

February 5, 2014


i Establishment employment data are available from the Current Employment Statistics program.  www.bls.gov/sae/  Unemployment statistics are available from the Local Area Unemployment Statistics program.  www.bls.gov/lau/

ii The Conference Board,  http://www.conference-board.org/data/bci/index.cfm?id=2180

iii Massachusetts Department of Employment and Training

iv The Conference Board, Help Wanted Online® (HWOL)

v Secretary of the Commonwealth of Massachusetts

vi U.S. Census Bureau, Building Permits Survey

References:

Clayton-Matthews, A., & Stock, J. H. (1998/99). An Application of the Stock-Watson Index Methodology to the Massachusetts Economy. Journal of Economic and Social Measurement, 25, 183-233.

Crone, T. M., & Clayton-Matthews, A. (2005). Consistent Economic Indexes for the 50 States. The Review of Economics and Statistics, 87(4), 593-603.

Stock, J. H., & Watson, M. W. (1989). New Indexes of Coincident and Leading Economic Indicators. NBER Macroeconomics Annual, 351-394.

Tebaldi, E., & Kelly, L. (2012). Measuring economic conditions: an extension of the Stock/Watson methodology. Applied Economic Letters, 19, 1865-1869.

The Conference Board. (n.d.). How to Compute Diffusion Indexes. Retrieved January 2014, from The Conference Board: http://www.conference-board.org/data/bci/index.cfm?id=2180