Business cycle forecasting through economic indicators: A dynamic approach

Anders Remme Olsen

Student thesis: Master thesis


After a long period of economic growth, USA reached a peak in economic activity in December 2007. Following this peak the economy entered the deepest recession since the great depression, only to confirm the existence of business cycles. Even though there are extensive research proving that the US economy have been moving in cycles, with periods of growth and contraction for as long as we have empirical data, there are still signs that market participants find it difficult to adjust to changes in macroeconomic growth. This paper argues the possibility of preparing for future changes in macroeconomic growth, and hence take the best possible advantage of both upside and downside macroeconomic risks, through business cycle forecasting. It also performs a successful ex post forecast of the business cycle peak of December 2007, and show that forecasting indeed can give vital and timely information. Even though all business cycles of the past have some unique characteristics, they also have some important similarities. In this paper I use these empirical similarities together with economic theory, to extract predictive information from a group of economic indicators in the goal of gaining qualified expectations on the future growth of the business cycle. The forecasting approach used in this paper stress the importance of flexible and dynamic qualities to be able to evolve together with the modern economy. As the analysis put much weight on a broad understanding of the current state of the economy, and on the potential strengths and problems going forward through fundamental analysis of the respective indicators, it also hold enough flexibility to be able to adapt to future changes in economic behavior. These dynamic and flexible qualities strengthen the possibilities of such forecasts being valuable also in the future. As the economy is constantly evolving, ex post forecasts are important tools for further research on the current predictive powers of economic indicators. Such research help us understanding past business cycles, and give useful insight in regards to what we should expect ahead of future peaks and troughs. The forecast of the US business cycle peak in December 2007 gives a good introduction to the analysis of economic indicators, and confirms the value of business cycle forecasting through economic indicators. This analysis shows that the signs of the approaching recession were obvious, most notably in the form of an inverted yield curve and an overheated housing market, at dates between 6 and 12 months ahead of the peak. This helps confirming the validity of macroeconomic forecasting, and stands as an example that such analysis could be of great value to macroeconomic risk management and to the preparations of future strategies.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2009
Number of pages86