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Chicago Fed National Activity Index (CFNAI) can predict US economic uncertainty


What is the Chicago Fed National Activity Index (CFNAI)?

Many people use unemployment rate% to measure the US economy. The correlation between unemployment rate% and GDP growth is always negative. However, many people now realize that it is wrong.

Unemployment rate% has not been a good predictor since 2008. There was a precaution telling you that the unemployment rate% cannot accurately measure the economy in the past.

Using CFNAI to measure the economy is better than using the unemployment rate%.

The CFNAI is a weighted average of 85 existing monthly indicators of national economic activity. It is constructed to have an average value of zero and a standard deviation of one. Since economic activity tends toward trend growth rate over time, a positive index reading corresponds to growth above trend and a negative index reading corresponds to growth below trend.

The 85 economic indicators that are included in the CFNAI are drawn from four broad categories of data: production and income; employment, unemployment, and hours; personal consumption and housing; and sales, orders, and inventories. Each of these data series measures some aspect of overall macroeconomic activity. The derived index provides a single, summary measure of a factor common to these national economic data.

The CFNAI corresponds to the index of economic activity developed by James Stock of Harvard University and Mark Watson of Princeton University in an article, "Forecasting Inflation," published in the Journal of Monetary Economics in 1999. The idea behind their approach is that there is some factor common to all of the various inflation indicators, and it is this common factor or index, that is useful for predicting inflation. Research has found that the CFNAI provides a useful gauge on current and future economic activity and inflation in the United States.

How to use it?

A zero value for the CFNAI has been associated with the national economy expanding at its historical trend (average) rate of growth; negative values with below-average growth (in standard deviation units); and positive values with above-average growth.

Most people may use CFNAI-MA3 because the rolling moving average can de-noise. Shading indicates official periods of recession as identified by the National Bureau of Economic Research; the vertical line indicates the most recent business cycle peak. Following a period of economic expansion, an increased likelihood of a recession has historically been associated with a CFNAI-MA3 value below –0.70. Conversely, following a period of economic contraction, an increased likelihood of expansion has historically been associated with a CFNAI-MA3 value above –0.70 and a significant likelihood of expansion has historically been associated with a CFNAI-MA3 value above +0.20.

However, using CFNAI to predict an economic recession is better, especially the CFNAI Diffusion index.



The CFNAI Diffusion Index represents the three-month moving average of the sum of the absolute values of the weights for the underlying indicators whose contribution to the CFNAI is positive in a given month less the sum of the absolute values of the weights for those indicators whose contribution is negative or neutral in a given month. Periods of economic expansion have historically been associated with values of the CFNAI Diffusion Index above –0.35.

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