Business Cycle Indexes: Does a Heap of Data Help?

Business cycle indexes are used to get a timely and frequent description of the state of the economy and its likely development in the near future. This paper discusses two methods for constructing business cycle indexes, the traditional NBER method and a recently developed dynamic factor model, and compares these methods for the euro area. The results suggest that a reliable index can be constructed from a limited number of series that are selected using economic logic. We next decompose this index to identify variables that seem to be driving the euro area cycle.Business cycle indexes are used to get a timely and frequent description of the state of the economy and its likely development in the near future. This paper discusses two methods for constructing business cycle indexes, the traditional NBER method and a recently developed dynamic factor model, and compares these methods for the euro area. The results suggest that a reliable index can be constructed from a limited number of series that are selected using economic logic. We next decompose this index to identify variables that seem to be driving the euro area cycle. This analysis reveals important differences across countries in these driving variables.