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February 2012, No. 3808
Statistics and surveys
The German IFO survey for February yielded a business climate index of 109.5, 1.2% higher than last month’s reading. Thisresult was stronger than markets had expected following the decline reported yesterday in the ‘flash’ Markit purchasingmanagers’ composite index (PMI) to 51.7 this month from 52.9 in January. In truth, it is not unusual for the results from thesesurveys to diverge over the short run. There are differences in coverage. The IFO seeks responses from companies operating inmanufacturing, construction and wholesale and retail trade, whereas the Markit composite measure draws on a sample-population of companies in manufacturing and certain service sectors. But this does not fully account for the differences inresults. For the current month, the indices for manufacturing alone, which ought to relate to coterminous categories, alsomoved in opposite directions, with the IFO measure rising and the PMI falling. Over the longer term, it is true, the two surveystell broadly similar stories but, on those occasions when they give conflicting signals, that is no help in deciding which of themis providing a reliable indication of the trend in the economy.Germany is not the only country where this problem arises. The Bank of England’s MPC noted at its 8-9 February meeting thatthere were similar difficulties in the UK. The minutes drew attention to the sharp increases in the CIPS/Markit manufacturingand services indices in January. Both had been above their series averages. Nevertheless, ‘the strength in the CIPS/Markitsurveys had not been matched by other survey evidence; the CBI and British Chamber of Commerce survey expectations hadboth suggested a further contraction in GDP in the first quarter.’ It appears that MPC members were inclined to side with theCIPS/Markit version of reality on the grounds that ‘past statistical relationships had suggested they were the most informativeindividual survey indicators of output growth’, a comment that the compilers might do well to squirrel away for future use intheir promotional material. But the clinching argument in favour of the upbeat CIPS/Markit message on the economy, in theeyes of MPC members, seems to have been that the UK CIPS/Markit surveys had risen in common with those in many othercountries around the world. If that was a sound way of assessing January’s survey results, how are MPC members now tointerpret the downturn in February’s ‘flash’ PMI data for the euro zone? If they are to be consistent, should they not tempertheir confidence that January’s 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 reflectedan improvement in business conditions following the ECB’s LTRO although it seemed unlikely that it could have led to a sharppickup in output is such a short space of time’. It seems here that the MPC was trying very hard not to deviate from thecompiler’s line that the survey results reflect current activity and (apart from the services sector business expectations sub-index) are free of expectational influences. It would seem to follow that the LTRO could not have much impact on the Januarysurvey results because it would not have had time to affect positively such objective quantities as output, new orders andemployment. The upturn in PMI indices in January must, it appears, be attributable to some other factors. However, this is tooverlook the point that the questionnaires on which the indices are based are filled in by people. The responses they give willbe influenced by the psychological state they are in. When they are asked to specify whether output rose, fell or stayed thesame, 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 ussay, by an amount that hardly makes a difference. Whether such a situation is described as a rise in output or as output stayingthe same is likely to depend on how optimistic the respondent is feeling. In other words, it is not possible to excludepsychological factors from this type of survey information and the puzzle the MPC posed regarding the effect of the LTRO issolved. It may, of course, be very useful to know whether companies are seeing an improvement in business conditions, evenwhen business is not actually improving. Nevertheless, attempts to correlate the results of such surveys with past or likelyfuture 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 companiesthat survive, that is, the relatively successful ones, not from those that fail. Survey compilers try to control for this possibledistortion in their results but can never be completely sure how well they succeed. Given the logistical challenge of conductinga survey, a greater proportion of large-company activity is likely to be surveyed than that of small and medium-sizedcompanies. That may not always matter. The business conditions facing large and smaller companies may be similar for muchof the time. However, it would be reasonable to suppose that, at present, company size is conferring a significant competitiveadvantage. After all, large companies are enjoying ready access to sources of capital, partly as a result of the Bank of England’s ‘quantitative easing’, whereas smaller companies remain severely credit-constrained. Consequently, the numericalindices constructed out of business survey responses seem likely to be overstating the strength in economic activity measurableby GDP. The MPC might do better to heed the qualitative reports that the Bank’s 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 anuanced insight into why the economy is behaving as it is.