ZEW Indicator of Economic Sentiment Exceptionally Good

A study carried out by the Mannheim Centre for European Economic Research (ZEW) has drawn on econometric methods to analyse the quality of prognoses provided by the two indicators - the Ifo Business Climate Index (ifo-Geschäftserwartungen) and the ZEW Indicator of Economic Sentiment. Analysis has suggested that the ZEW Indicator of Economic Sentiment provides reliable prognoses for one month longer than the Ifo indicator. The exceptionally good quality of early indicators provided by the ZEW Indicator of Economic Sentiment, about which there has already been a great deal of speculation, has therefore been confirmed.

The Ifo Business Climate Index, as well as the ZEW Indicator of Economic Sentiment, give early indications of changes in the annual rate of change in industrial production in Germany. The ZEW Indicator of Economic Sentiment provides indicators for the coming six month period; the Ifo Business Climate Index provides data for a maximum of four months. The business expectations of the financial analysts included in the ZEW survey can therefore provide a basis for mid- to long-term prognoses.

The aim of the ZEW study is to compare the information provided by the Ifo Business Climate Index with that provided by the ZEW Indicator of Economic Sentiment and thus to analyse the quality of these indicators as an early indicator of the economic developments in Germany. Both indicators are determined on the basis of monthly surveys. In case of the Ifo indicator, businesses are surveyed. For the ZEW Finance Market Survey, analysts from the banking sector, insurance industry and large corporations are surveyed.

The ZEW study illustrates that in comparison to a naive prognosis provided simply by looking at previous developments in the industrial sector, both indicators are able to give a much better prediction of future developments in industrial production. A prognosis based on the ZEW Indicator of Economic Sentiment provides between three and twelve months worth of significantly better results than a naive prognosis. The Ifo indicator provides significantly better data for only six months.

Analysis has also shown that combining data from the ZEW Indicator of Economic Sentiment and the Ifo Business Climate Index, rather than using only a single indicator, significantly improves the short and mid-term quality of prognoses. It seems that the two indicators provide complementary information.

Contact

Prof. Dr. Michael Schröder, Phone:+49(0)621/1235-140, E-mail: schroeder@zew.de

Dr Felix Hüfner, E-mail: huefner@zew.de