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Economic Insights Statistics and surveys

23 February 2012, No. 3808

The German IFO survey for February yielded a business climate index of 109.5, 1.2% higher than last months reading. This result was stronger than markets had expected following the decline reported yesterday in the flash Markit purchasing managers composite index (PMI) to 51.7 this month from 52.9 in January. In truth, it is not unusual for the results from these surveys to diverge over the short run. There are differences in coverage. The IFO seeks responses from companies operating in manufacturing, construction and wholesale and retail trade, whereas the Markit composite measure draws on a samplepopulation of companies in manufacturing and certain service sectors. But this does not fully account for the differences in results. For the current month, the indices for manufacturing alone, which ought to relate to coterminous categories, also moved in opposite directions, with the IFO measure rising and the PMI falling. Over the longer term, it is true, the two surveys tell broadly similar stories but, on those occasions when they give conflicting signals, that is no help in deciding which of them is providing a reliable indication of the trend in the economy. Germany is not the only country where this problem arises. The Bank of Englands MPC noted at its 8-9 February meeting that there were similar difficulties in the UK. The minutes drew attention to the sharp increases in the CIPS/Markit manufacturing and services indices in January. Both had been above their series averages. Nevertheless, the strength in the CIPS/Markit surveys had not been matched by other survey evidence; the CBI and British Chamber of Commerce survey expectations had both suggested a further contraction in GDP in the first quarter. It appears that MPC members were inclined to side with the CIPS/Markit version of reality on the grounds that past statistical relationships had suggested they were the most informative individual survey indicators of output growth, a comment that the compilers might do well to squirrel away for future use in their promotional material. But the clinching argument in favour of the upbeat CIPS/Markit message on the economy, in the eyes of MPC members, seems to have been that the UK CIPS/Markit surveys had risen in common with those in many other countries around the world. If that was a sound way of assessing Januarys survey results, how are MPC members now to interpret the downturn in Februarys flash PMI data for the euro zone? If they are to be consistent, should they not temper their confidence that Januarys UK surveys registered the first phase in a sustainable economic upswing? The MPC minutes further commented on the global PMIs that it was possible that the CIPS/Markit surveys might have reflected an improvement in business conditions following the ECBs LTRO although it seemed unlikely that it could have led to a sharp pickup in output is such a short space of time. It seems here that the MPC was trying very hard not to deviate from the compilers line that the survey results reflect current activity and (apart from the services sector business expectations subindex) are free of expectational influences. It would seem to follow that the LTRO could not have much impact on the January survey results because it would not have had time to affect positively such objective quantities as output, new orders and employment. The upturn in PMI indices in January must, it appears, be attributable to some other factors. However, this is to overlook the point that the questionnaires on which the indices are based are filled in by people. The responses they give will be influenced by the psychological state they are in. When they are asked to specify whether output rose, fell or stayed the same, they are very unlikely to find that it is at exactly the same level as in the previous month. But it may be higher, let us say, by an amount that hardly makes a difference. Whether such a situation is described as a rise in output or as output staying the same is likely to depend on how optimistic the respondent is feeling. In other words, it is not possible to exclude psychological factors from this type of survey information and the puzzle the MPC posed regarding the effect of the LTRO is solved. It may, of course, be very useful to know whether companies are seeing an improvement in business conditions, even when business is not actually improving. Nevertheless, attempts to correlate the results of such surveys with past or likely future changes in GDP are liable to lead policymakers and market participants astray. One problem with all business surveys is what might be termed survivor bias. Responses are collected only from companies that survive, that is, the relatively successful ones, not from those that fail. Survey compilers try to control for this possible distortion in their results but can never be completely sure how well they succeed. Given the logistical challenge of conducting a survey, a greater proportion of large-company activity is likely to be surveyed than that of small and medium-sized companies. That may not always matter. The business conditions facing large and smaller companies may be similar for much of the time. However, it would be reasonable to suppose that, at present, company size is conferring a significant competitive advantage. After all, large companies are enjoying ready access to sources of capital, partly as a result of the Bank of Englands quantitative easing, whereas smaller companies remain severely credit-constrained. Consequently, the numerical indices constructed out of business survey responses seem likely to be overstating the strength in economic activity measurable by GDP. The MPC might do better to heed the qualitative reports that the Banks regional Agents present. These, it is true, contain few quantitative estimates of the kind that econometricians like to play with. On the other hand, they do provide a nuanced insight into why the economy is behaving as it is.

Stephen Lewis: Tel (0)20 7190 7193, or e-mail: sjlewis@monumentsecurities.com

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www.monumentsecurities.com

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Stephen Lewis: Tel (0)20 7190 7193, or e-mail: sjlewis@monumentsecurities.com