Friday, November 18, 2011

The Problem with the Leading Economic Indicator Index

This morning, the index of Leading Economic Indicators (LEI) was reported as being up 0.9%, which was better than analyst expectations.  Below is a chart comparing the LEI to the index of Current Economic Indicators.

The LEI continues to hit new all time highs, and has increased substantially since 2009.  Unfortunately the CEI hasn't quite kept pace.  The LEI is supposed to foreshadow increases in CEI, but clearly it hasn't.  The divergence between the two indices would seem to suggest that the LEI isn't doing a good job of highlighting factors that truly lead economic activity.  If it were doing a good job, the CEI would be rising at a similar rate and at least have recovered to its pre-recession high.

A closer inspection of the underlying components of the LEI show why it has painted a skewed picture of  economic prospects:

Click to Enlarge
The LEI is a broken indicator because it is too heavily influenced by monetary policy.  In October, the interest rate spread (steep yield curve) contributed 0.22% to the 0.9% increase in leading indicators.  Even though the steepness of the yield curve has changed only marginally since 2009, the interest rate spread has pushed the LEI higher by roughly this amount every month since the Fed started easing.  This accounts for much of the divergence from CEI.  As long as the curve is held artificially steep, it will continue to drive LEI higher.

The fact that LEI is a broken indicator is as much an indictment of failed Keynesian monetarism as it is a statement of the inadequacy of a this particular metric.  LEI is driven higher by the flawed theory that easy monetary policy can stimulate economic production.  CEI shows that this premise is entirely incorrect.  Simply put, CEI isn't rising as fast as LEI because monetary policy has less of an effect on the real economy than monetarists would like to believe.

No comments:

Post a Comment

For compliance reasons, I don't post comments to the site, but I do like hearing from readers and am happy to answer any questions. Feel free to use the comment box to get in touch. Please leave an email address in your comment so that I can write back, or email me directly at