Key to the Future

One of the most important guideposts of the U.S. economy goes by the jawbreaking name of Diffusion Indexes of Business Indicators. The indexes, compiled by the National Bureau of Economic Research, are becoming widely used by major corporations and such top economists as Dr. Raymond J. Saulnier, head of the President's Council of Economic Advisers, and his predecessor, Arthur Burns, to predict the course of the economy. Last week the diffusion indexes gave a signal that the economy had about touched bottom.

Leaders & Laggards. The indexes use statistics from 21 different areas that cover the important segments of the nation's economy--production, employment, income, prices, etc. When all statistics are moving up, the diffusion indexes read 100. When all are moving down, the indexes are zero. If half are moving up and half down, the indexes are 50. When the indexes drop below 50, it means the economy is contracting; when they rise above 50, the economy is expanding. The basic 21 are broken down into three groups called 1) the Leading Series, 2) the Coincident Series, and 3) the Lagging Series (see chart).

The Leading group is the most important because it generally gives the first signals as to where the economy is going rather than where it has been. It includes areas that have historically risen and fallen from four to nine months before the overall economy has changed course. Among the figures used in the Leading group: average man-hours worked in basic manufacturing industries, Dow-Jones industrial averages, new orders for durable goods, spot commodity prices, F. W. Dodge reports on industrial and residential construction contracts.

The Coincident Series includes key areas that have traditionally risen and fallen along with the general business cycle, e.g., corporate profits, industrial production. The Lagging Series includes areas that generally lag behind the curve of the economy, e.g., manufacturers' inventories and interest rates on business loans. Finally, the Leading, the Coincident and the Lagging Series are added together in a composite index, which is less sensitive but more accurate than the Leading Series alone. In the past, when the Leading Series turned in one direction and the Composite Series moved in the same direction several months afterwards, the economy has usually followed in that direction. Therefore, the leaders give the first clues, and the composites later confirm them as a trend.

Alarms & Accuracy. First compiled by Burns, now head of the National Bureau of Economic Research, the indexes have been expanded and sharpened by Bureau Economist Geoffrey Moore. As with all indicators, the diffusion indexes have produced some false alarms. But the Leading Series has forecast all the postwar recessions. Last May 1957, two months before the economy reached the peak, the Leading group nosed down to signal trouble ahead. But the real warning came last August, when the composite index of all 21 areas started a fast slide.

Last week many of the lead indicators were pointing up. The Leading group is expected to show a rise for May, and climb above the 50 mark for the first time in a year. This is a good though not infallible sign that the economy has seen the worst. Said Economist Moore: "The way these indicators have behaved, an upturn in business activity should come during the second half of 1958. But business activity may not return to the peak levels of last July until late 1959 or early 1960.''

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