A New Index of the Business Cycle

Vol. 19, No. 3, 2021

William Kinlaw, Mark Kritzman and David Turkington

The authors introduce a new index of the business cycle that uses the Mahalanobis distance to measure the statistical similarity of current economic conditions with past episodes of recession and robust growth. Their approach has a key advantage compared to approaches that simply aggregate data, such as the Conference Board indexes, or approaches that rely on regression models. It considers the distribution of recession data separately from the distribution of growth data. This feature, along with the construction of the index as a relative probability, has the consequence of shifting the weights that are placed on the index inputs based on their prevailing values. In addition, their framework makes it possible to measure how the relative importance of the economic variables from which the index is constructed varies through time, which yields valuable insights about the dynamics of the business cycle.