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Barometric Forecasting Techniques

Barometric techniques examine the relationships between causal or coincident events to predict future events. This approach is based on the logic that key current developments can serve as a barometer of the future. This approach assumes the key developments can be identified, measured and recorded as a statistical time series. The barometric or what is also called the leading indicators approach to forecasting is often traced to work done at the National Bureau of Economic Research from the 1920s through the 1940s.

A leading indicator predicts three to six months in the future another event. Examples of indicators include: payroll employment, personal income less transfer payments, an index of industrial production, stock prices, changes in business inventories, consumer expectations, building permits, new orders for goods and materials and retail sales.

Caveats about Barometric Forecasting and Leading Indicators

"Like all forecasting techniques, the leading indicator method has its limitations. For instance:

  • While the leading indicator may warn us about a change in the direction of the business cycle, they do not provide us with very reliable information about the magnitude of that change.
  • Moreover, the magnitude of change of the indicator in any one direction is not necessarily a measure of how good or bad the economy is likely to get. It is only when the indicator clearly reverses direction that its value as a forecasting tool is relevant.
  • The component indicators of the overall leading indicator often are not consistent with one another in their predictions. Rarely do all indicators signal a change in direction at the same time.
  • It is hard to decide when a leading indicator is signaling a true turn in the cycle or is showing a variation that will be reversed in subsequent observations. Rules of thumb like 'three consecutive downturns during an expansion signal a recession' and 'three consecutive upturns during a recession indicate an end to that recession' are not always reliable.
  • Ironically, the widespread use of a reasonably reliable leading indicator may, in itself, lead to less reliability in the indicator over time. This can happen if players in the economy act on the forecast and alter either the economic outcome or the "lead" time between the indicator and the economy.

"Despite its drawbacks, a leading indicator series, in conjunction with other forecasting results, can help economists, business and government predict and prepare for significant changes in the economic environment."

from "Forecasting the Economy with Leading Economic Indicators" at URL

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