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June 23, 2011

NFCI in Your Toolbox

By Cindy Ivanac-Lillig

When evaluating and forecasting the U.S. economy, the challenges are numerous. What information offers the most predictive value? There are many good pieces of data. Economists affectionately call these “leading indicators.” Some examples of leading indicators include number of new building permits (for the housing market) and the number of temporary workers hired (for the labor markets). These are fairly intuitive and important.

However, we also have rich financial markets that tend to be forward-looking and can give us vital information to help evaluate and/or forecast economic activity. But which indicator of financial market health is best? The S&P 500 is interesting but it is weighted heavily toward certain types of instruments. No one argues about the importance of looking at capital markets’ indices, but there aren’t many good, widely available tools to evaluate the financial market conditions more broadly and easily.

Now help is here. The Chicago Fed has recently introduced something called the National Financial Conditions Index (NFCI) that just might be the tool you need for your forecasting toolbox. There are some similar composite indices around, but none that represents 100 indicators and is released weekly. The volume of historical data that this index has and the breadth of instruments covered make it very interesting.

The index combines 100 indicators’ worth of data. It weighs them to mirror the relative importance of the data to historical fluctuations. The indicators that are most heavily weighted are from the repo, short-term treasuries, commercial paper, and corporate bond markets. The value that is published represents how far from the historical average the current data is. So, if the NFCI is in positive territory, the index is above the historical average. A positive reading indicates tighter financial conditions or more stress in the financial market, and a negative value means better or looser financial conditions.

The link between financial conditions and future economic growth is strong. Having lived through the last few years, you probably didn’t need me to tell you that. Check out this new tool and let me know what you think. How will you use it?

Here's an interview with one of the economists responsible for the NFCI:

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Posted by Cindy at 8:31 PM | Comments (1) | TrackBack