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Constructing Leading Economic

Indicators for the Philippine Economy


using Dynamic Factor Models

Dennis Mapa, Joselito Magadia, Manuel Leonard Albis


School of Statistics
University of the Philippines, Diliman

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Outline of the Presentation

I. The GDP and LEIS


II. Mixed Frequency Models for GDP
a. Model 1: Hybrid DFM-VAR
b. Model 2: DF-Mixed Frequency Model
c. Forecasting Performance
IV. Conclusion

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
The Gross Domestic Product
• Gross Domestic Product (GDP), published by the
Philippine Statistics Authority (PSA), is the broadest
measure of the overall economic activity

• The official GDP estimates are released by the PSA about


60 days after the reference quarter for the 1st, 2nd and 3rd
Quarters and 30 days after for the 4th Quarter

• This delay is the reason why researchers are interested in


alternative methodologies to provide insights on the “real
time economic activity” using economic indicators that
are available at a higher frequency (e.g. monthly, weekly,
daily) than the quarterly GDP
13th National Convention on Statistics
October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
The Leading Economic Indicator
• A timely assessment on the movements of the GDP is
important to be able to guide policy makers to come up
with appropriate policies to mitigate, say the impact of a
shock

• Leading Economic Indicator System (LEIS), developed


jointly by the PSA and the National Economic and
Development Authority (NEDA)

• It provides a one-quarter-ahead forecast of the movement


of the GDP and seeks to answer the question whether the
GDP is expected to go up or go down in the succeeding
quarter
13th National Convention on Statistics
October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Challenges Encountered
• Short Time Series Horizon - Practitioners have hundreds
of series at their disposal, although most of them are not
desirably long enough (e.g. 20 to 40 years of quarterly data)

• Mismatched frequencies of data – Available economic


indicators have different frequencies, i.e. CPI is reported on
a monthly basis, exchange rate reported daily, and GDP
reported quarterly

• Aggregation – How to create a composite index of


economic movement from incomplete and mismatched
frequencies of data?

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Objectives of Study
• Provide alternative models to temporal aggregation by
proposing a multi-frequency model.

• Specifically, estimate a model with quarterly series on the


left-hand side (GDP growth) and monthly economic
indicators as explanatory variables (right-hand side)

• To develop and evaluate potential models in nowcasting


both the movements and the growth rates of the
country’s GDP:
1. Hybrid Dynamic Factor-Vector AutoRegressive (DF-
VAR) model
2. Dynamic Factor-Mixed Frequency (DF-MF) model

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Contributions to the LEIS

• Interaction of multi-frequency variables can be


assessed without resorting to data aggregation (e.g.
monthly exports can be used to predict intra-quarter
value of GDP)

• A multi-frequency model can generate monthly


forecasts (nowcast) using monthly economic
variables.

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
II. Mixed Frequency Models
for GDP

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Indicators of Economic Movement

Variable
Gross Domestic Product (Official Seasonally Adjusted Series)
National Government Expenditures
National Government Revenues
Government Spending under GFCE (COE less Interest Payments less
Subsidy)
Public Construction Spending (Infrastructure & other capital outlays + Capital
transfers to LGUs)
Exports
Exchange Rate
Gross International Reserves
Imports
Terms of Trade
Peso/Euro exchange rate
Peso/SGD exchange rate
Peso/yen exchange rate
Remittances (Cash)

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Indicators of Economic Movement

Variable
PSEI
Consumer Price Index
Deposit rate: Savings
Dubai Crude
Libor 3m
M2: Money Supply
Manufacturing: Value of Production Index
Retail Sale: Price of Rice (Regular-milled)
Sibor 3M
Tbill rate:364
Tbill rate: 91
Time deposit rate (Long-term)
Time deposit rate(Short-term)

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Indicators of Economic Movement

Variable
Visitor arrival
Wholesale Price Index
Meralco Sales
Bank Average Lending Rate
UKB Loans Outstanding
Registered Stock Corporations and Partnership
Business Expectation Survey (Current Quarter)
Business Expectation Survey (Next Quarter)
Consumer Expectation Survey (Current Quarter)
Consumer Expectation Survey (Next Quarter)

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Preliminary Tests:
Unit Root and Seasonality
• Prior to building the models, the time series data are
tested for the presence of unit root/s using the
Augmented Dickey-Fuller and the Dickey-Fuller-
Generalized Least Squares tests

• For series with seasonality, the corresponding


seasonally-adjusted values may be generated using
the X-13/12 procedure

• Corresponding transformations were applied on the


series if necessary

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Model 1: Hybrid DFM-VAR

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Hybrid Dynamic Factor VAR Model
• The procedure closely follows the approach of Chow
and Choy (2009) in analyzing business cycles in
Singapore that used Principal Components Analysis in
the extraction of the latent dynamic factors

• The Hybrid DFM-VAR model involves a two-step


process:
Step 1: Generate the dynamic factors using Principal
Components Analysis (PCA) – basically to reduce the
dimension of the data
Step2 : Run the Vector AutoRegressive (VAR) Model
using the aggregated factors, additional “stand alone”
variables, and GDP
13th National Convention on Statistics
October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Factors and Stand Alone Variables
• The PCA suggested six factors generally named as:
(1) Prices, (2) Exchange Rates, (3) Interbank Offered
Rates, (4) Investments, (5) Trade, (6) Spending
• Three stand-alone variables were selected: (1)
Remittances, (2) Visitors, (3) Business Expectations
Survey outlook
Factor 1 WPI, Price of Dubai Crude, CPI, Price of Rice
Factor 2 Exchange Rates: Yen, Euro, USD, SGD
Factor 3 LIBOR, SIBOR
TBILL 364, TBILL, Short-Term TD Rate, SEC Registered
Factor 4
Corporations, Manufacturing Value of Production Index
Factor 5 Terms of Trade, Exports, Money Supply, Imports, PSEI
National Government Expenditure, Public Construction
Factor 6
Spending Government Spending

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Vector Autoregressive Model
• The approach of Sims (1980) was to view all variables
as endogenous

• Each endogenous variables by regressing its past


values and the past values of the other variables in
the system

• VAR(1) Model:

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Performance of Hybrid DFM-VAR

• Percentage of correctly predicted


movement of GDP (seasonally adjusted):
77%

• Mean Error in Forecasting GDP growth


(seasonally adjusted): 0.38 percentage
point

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Model 2: DF-Mixed
Frequency Model

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
The DF-Mixed Frequency Model
• The procedure closely follows the approach of Gerlach and
Yiu (2004) in nowcasting the GDP of Hong Kong

• The DFM-Mixed Frequency model involves a three-step


process:
Step 1: Determine the potential variable groupings using
PCA
Step 2: Extract the dynamic factors from each of the
variable groupings using State-Space DFM
Step 3: Estimate a State-Space Time Varying Model for
GDP

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
State-Space Model
• The extraction of the latent dynamic factors and the
prediction of GDP was done using the State-Space model

• The State-space model (Kalman 1960) is a general time-


series model for expressing dynamic systems that involve
unobserved state variables

• A state-space model consists of two equations:


– Measurement Equation: Describes the relation between
observed variables (data) and unobserved state variables
– Transition Equation: Describes the dynamics of the
state variables; it has the form of a first-order difference
equation in the state vector
13th National Convention on Statistics
October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
State-Space Model:
Dynamic-Factor Model

Measurement Equation
,

Transition Equation
,

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
State-Space Model:
Time-Varying-Parameter Model
Measurement Equation
,

Transition Equation

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Predicting GDP Growth
Seasonally
Month Adjusted
GDP
2001JAN .
Seasonally 2001FEB .
Data Conversion 2001MAR 0.3 The Kalman Filter
QTR Adjusted
GDP 2001APR . Algorithm will
2001Q1 0.3 GDP growth 2001MAY . estimated the missing
2001Q2 1.2 2001JUN 1.2
rates are treated 2001JUL . GDP values from the
2001Q3 1.2
2001Q4 0.3 as a monthly 2001AUG . dynamic factors and
series with 2001SEP 1.2 stand-alone variables
2001OCT .
missing 2001NOV .
observations 2001DEC 0.3 The estimated model is
also used in forecasting

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Performance of DF-Mixed Frequency

• Percentage of correctly predicted


movement of GDP (seasonally adjusted):
94%

• Mean Error in Forecasting GDP growth


(seasonally adjusted): 0.59 percentage
point

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Conclusions
• This paper proposes models in nowcasting the movement and
growth rates of the country’s quarterly Gross Domestic Product
(GDP) using 32 monthly variables and 1 quarterly indicator, in
addition to the one- and two-factor DF model

• The DF-VAR and DF-MF are alternative models to the usual


time series econometric models used in forecasting GDP
growth rates utilizing temporal aggregation

• The assessment of the models, in terms of the percentage of


correctly tracking the movement of the GDP, suggests that
hybrid models are promising as nowcasting tools and can serve
as alternative (and better) models to the current LEIS used by
the NEDA and PSA.
13th National Convention on Statistics
October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City
Acknowledgements

• The authors acknowledge the support of the National


Economic and Development Authority (NEDA) and the
Bangko Sentral ng Pilipinas (BSP) for this research

• The author is indebted to the research support


provided by the members of the Poverty and Hunger
Research Laboratory of the School of Statistics,
University of the Philippines.

13th National Convention on Statistics


October 3-4, 2016, EDSA Shangri-La Hotel, Mandaluyong City

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