Sunday, June 29, 2014

ADS Perspective on the First-Quarter Contraction

Following on my last post about the first-quarter GDP contraction, now look at the FRB Philadelphia's Aruoba-Diebold-Scotti (ADS) Index. 2014Q1 is the rightmost downward blip. It's due mostly to the huge drop in expenditure-side GDP (GDP_E), which is one of the indicators in the ADS index. But it's just a blip, nothing to be too worried about. [Perhaps one of these days we'll get around to working with FRB Philadelphia to replace GDP_E with GDPplus in the ADS Index, or simply to include income-side GDP (GDP_I) directly as an additional indicator in the ADS Index.]

Plot of ADS Business Conditions Index in 2007

Source: FRB Philadelphia

One might wonder why the huge drop in measured GDP_E didn't cause a bigger drop in the ADS Index. The reason is that all real activity indicators are noisy (GDP_E is just one), and by averaging across them, as in ADS, we can eliminate much of the noise, and most of the other ADS component indicators fared much better. (See the component indicator plots.)

Note well the important lesson: both the ADS Index (designed for real-time analysis of broad real activity) and GDPplus (designed mostly for historical analysis of real GDP, an important part of real activity) reduce, if not eliminate, measurement error by "averaging it out."

All told, ADS paints a clear picture: conditional on the underlying indicator data available now, real growth appears to be typical (ADS is constructed so that 0 corresponds to average growth) -- not especially strong, but simultaneously, not especially weak.