Evaluating early warning and coincident indicators of business cycles using smooth trends

Abstract

We present a composite coincident indicator designed to capture the state of the Spanish economy. Our approach, based on smooth trends, guarantees that the resulting indicators are reasonably smooth and issue stable signals, reducing the uncertainty. The coincident indicator has been checked by comparing it with the one recently proposed by the Spanish Economic Association index. Both indexes show similar behavior and ours captures very well the beginning and end of the official recessions and expansion periods. Our coincident indicator also tracks very well alternative mass media indicators typically used in the political science literature. We also update our composite leading indicator (Bujosa et al., Journal of Forecasting, 2013, 32(6), 481–499). It systematically predicts the peaks and troughs of the new Spanish Economic Association index and provides significant aid in forecasting annual gross domestic product growth rates. Using only real data available at the beginning of each forecast period, our indicator one-step-ahead forecast shows improvements over other individual alternatives and different forecast combinations.