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INTERPRETATION OF THE

INDEX OF GENERAL

BUSINESS CONDITIONS



BY

WARREN M. PERSONS




/



HARVARD ECONOMIC SERVICE

CAMBRIDGE, MASS., U.S.A.

1922



INTERPRETATION OF THE INDEX OF GENERAL



BUSINESS CONDITIONS



WARREN M. PERSONS



MC/^



I. BUSINESS CYCLES

THE ebb and flow of industrial activity and
trade, the alternation of full employment
and unemployment, the rise and fall of prices,
wages, profits, and interest rates are familiar
characteristics of our economic system. This
ebb and flow of economic activity, this alterna-
tion of prosperity and depression constitutes the
business cycle.

The business cycle is clearly revealed over a
period of years by the wave-like variations in the
industrial, commercial, and financial statistics
which ordinarily serve as a basis for judgments
concerning the fundamental speculative, busi-
ness, and banking situation — for instance, sta-
tistics of wholesale commodity prices, rates on
commercial paper, pig-iron production, and bank
clearings. To illustrate the kind of variations
found in business statistics the monthly items of
two of the series just named — average wholesale



(Pt,



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prices and rates on commercial paper — are
given for a period of nearly 33 years in the chart
at the bottom of this page and the one following. 1
The curve representing wholesale prices shows
the average wholesale price of ten commodities
selected because, first, they are unusually sensi-
tive to price changes and are not greatly affected
by the seasons and second, they are of a varied
nature and are important to the industrial life of
the country. 2 The curve representing rates on
commercial paper shows the rate on 60-90 day
commercial paper in New York. These series

1 In this chart the logarithmic or ratio scale is used. Conse-
quently, equal percentage changes in each series are repre-
sented by equal vertical distances and the differences in the
violence of fluctuations of the two curves corresponds exactly
to the differences in percentage changes from minima to
maxima in the two series.

§£■ * The commodities are: cottonseed oil, coke, pig iron, bar
iron, pig zinc, mess pork, hides, print cloths, sheetings, and
worsted yarns. The prices of these commodities all have
similar major fluctuations.



Money Rates and Commodity Prices, 1890-1905
(Ratio scale)



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INTERPRETATION OF THE INDEX OF GENERAL BUSINESS CONDITIONS 3



reflect very clearly variations in business pros-
perity, and the most noticeable feature of the
curves is their cyclical movement. They, there-
fore, are well adapted for use in an index designed
to show fluctuations in general business condi-
tions.

A second noticeable feature of the chart is the
correspondence of the major wave movements of
the two curves. Comparison of these movements/
shows, however, that the crests of the waves fori
interest rates appe ar to fo llow , in point of time, '
the high points for commodity prices. But a
decision as to the precise relationship between
the wave movements, or cyclical fluctuations, of
interest rates and wholesale prices during periods
of alternating prosperity and depression is made
difficult by three disturbing influences: first, a
substantial season al movement in interest rates'
during each year, by which the rates are usually
low in the summer and high in the autumn, thus
disguising the cyclical movements; second, the
effects of such unusual events as the free silver
campaign of 1896, the outbreak of war with
Spain in the spring of 1898, the declaration of
war in Europe in July and August 1914, and the



great inflation of prices during the war; and
third, the diyeisei trends of the two series —
downward for interest rates and upward for com-
modity prices — for the whole period covered.

The two statistical series just considered, and
many other series connected with speculation
and security prices, business activity and com-
modity prices, or banking and interest rates,
reflect, as we have said, cycles of business prosper-
ity and depression, and therefore constitute the
raw material for the construction of an index of
general business conditions. In order to adapt
such raw material to our purpose — the securing
of an index which would measure and forecast
the ebb and flow of business — two statistical
operations had to be performed:

First, methods were devised for eliminating
the seasonal influences and long-time move-
ments from the various statistical series
utilized; and

Second, the series thus corrected were
sorted into groups according to the times at
which maximum or minimum points of the
cyclical fluctuations were reached.



Money Rates and Commodity Prices, 1906-22
(Ratio scale)




J906 1907 I90S 1909 1910



1911



I9ia 1913 1914 1915 1916 1917 1916 1919 1920 I9£l 1922



487369



4 /.INTERPRETATION 'QF THE INDEX OF GENERAL BUSINESS CONDITIONS



Chart I. — Pig-Iron Production: Actual Figures
{Unit: 1,000 gross tons)



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1903 1904 1905 1906 1907 1908 1909 1910 1911 1912 1913 1914 1915



1916



Explanation: The above chart shows the monthly production of pig iron
for the years 1903-16. As the United States, throughout this period, grew in
population and in the extent of its commercial activities, new iron furnaces
were set in operation and there was a gradual expansion in the total output of
the nation. This growth element, or long-time movement upward, in the



normal producing capacity of this industry has been represented in the
chart by the straight line fitted to the original items. Correction for this in-
fluence was accomplished by expressing the actual tonnage manufactured in
each month as a percentage of the corresponding " normal" production in-
dicated by the straight line. The resulting figures appear in Chart II below



MO



Chart II. — Pig-Iron Production: Figures Corrected for Long -Time Movement

{Percentages)




1903



1904



1905



1906



1907



1908



1909



1910



1912



1913



1914



1915



1916



Explanation: The solid line on the above chart represents pig-iron pro-
duction corrected for the long-time movement, but not for the seasonal
movement; the dotted line indicates the usual seasonal variation in the out-
put during the year. Correction for the seasonal influence was made by
taking the differences between the corresponding items of these two lines;



the results of this subtraction show in each case by how much the actual
production, after the long-time movement had been eliminated, exceeds or
falls short of the output normally to be expected for that month. These
differences (presented in Chart III below) are called "the corrected figures"
since both the long-time and seasonal movements have been removed.



+40



Chart III. — Pig-Iron Production : Corrected Figures
{Percentages)










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1903 1904 1905 1906 1907 1908 1909 1910 1911 1912 1913 1914 1915



1916



INTERPRETATION OF THE INDEX OF GENERAL BUSINESS CONDITIONS



Chart IV. — Interest Rates: Actual Figures
( Unit: one per cent per annum.)




Explanation: The above chart shows the actual rates on choice double-
name 60-00 day commercial paper by months for the years 1003-16 During
this period there was a gradual downward trend of discount rates, as shown
by the straight line fitted to the original items. Correction for this influence



was accomplished, as in the case of pig iron, by expressing the actual rate for
any month as a percentage of the corresponding "normal" rate indicated by
the straight line. The resulting figures appear in Chart V below



Chart V. — Interest Rates: Figures Corrected for Long-Time Movement

{Percentages)



160



140



120




100



803 1904



1906 1907



©08 1909



1912



1913



1914



Explanation: The solid line on the above chart represents the rates on 60-
00 day commercial paper corrected for the long time movement, but not for
the seasonal movement; the dotted line indicates the seasonal variation in
rates through the year. This variation, it is clear, is relatively greater than
that of pig-iron production (Chart II). Correction for the seasonal influence
was made by taking the difference between the corresponding items of these



two lines. The results of this subtraction show in each case by how much
the actual rate, after the long-time movement had been eliminated, exceeds
or falls short of the rate normally to be expected for that month of the year.
These differences (presented in Chart VT below) are called "the corrected
figures," since both the long time and seasonal movements have been re-
moved from them.



Chart VI. — Interest Rates: Corrected Figures
(Percentages)



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1906 1907 1903 I909 I9K)



1914



1913



1916



6 INTERPRETATION OF THE INDEX OF GENERAL BUSINESS CONDITIONS

Chart VII. — Corrected Figures for the Series of the Speculative Group (A), 1903-14



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1912 1913 1914-



1903 1904 1905 1906 1907 ■,,' 1908 1909 1910 1911

(A) Group average. (2) Average price of industrial stocks. (4) Average price of railroad bonds.

(1) Bank clearings of New York City (3) Average price of railroad stocks.



Chart VIII. — Corrected Figures for the Series of the Business Group (B), 1903-14




(B) Group average.

(5) Bank clearings of the United States outside New York City

(6) Bradstreet's index of wholesale commodity prices.



(7) United States Bureau of Labor Statistics' index of wholesale com-
modity prices. ,

(8) Pig-iron production.



Chart LX. — Corrected Figures of the Series of the Banking Group (C), 1903-14




1903



1904'



1905



1906



1907 1908



1909



1910



1911



1912



191,3



1914



(C) Group average.

(9) Interest rate on 60-90 day commercial paper in New York City. (n) Loans of New York City Clearing House banks (reversed).

(10) Interest rate on 4-6 months commercial paper in New York City. (12) Deposits of New York City Clearing House banks (reversed).



Chart X. — THE INDEX OF GENERAL BUSINESS CONDITIONS, 1903-14















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1911



1912



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Group averages for: (B) Business: wholesale prices of commodities and volume of business.

(A) Speculation: prices of securities and volume of stock sales. (C) Banking: Commercial paper rates and bank loans and deposits.



INTERPRETATION OF THE INDEX OF GENERAL BUSINESS CONDITIONS 7



Statistical series, thus corrected and thus
sorted, reflect accurately the cycles of specula-
tion, business and banking, and constitute the
data used in our Index of General Business
Conditions.

The purpose of the Index of General Business
Conditions published by the Harvard Economic
Service is to provide, first, a record of business
cycles, and second, a basis for forecasting busi-
ness conditions. A full explanation of the data
and technical methods used in constructing it is
given in Indices of General Business Conditions. 1
The explanation which follows is intended to
serve as a guide in interpreting the current index.

II. THE INDEX CHARTS, 1903-14
AND 1918-22

The precise method of constructing our Index
will be understood by referring to the charts on
pages 4, 5 and 6.

Charts I and TV present the actual figures for
two series chosen for illustration — pig-iron
production and interest rates. On the same
charts appear two straight lines which represent
the long-time movements of those series.

Charts II and V present the figures of the two
series corrected for the long-time movements
only. The usual seasonal movement of each
series is shown by the broken line.

Charts III and VI present the figures corrected
for both long-time movements and seasonal
influences. It is evident that the figures, thus
corrected, reveal the cyclical fluctuations more
clearly than do the crude data.

Charts VII to LX present the corrected figures
for the two series chosen for illustration, and ten
others. It will be seen that the twelve series are
sorted into three groups — group A, being given
in Chart VII, group B in Chart VIII, and group
C in Chart LX — according to the times at which
maximum and minimum points of the series
occur. Group A, consisting of series which fluc-
tuate first, either upward or downward, are all
series depending upon speculation; group B,
consisting of series in which the fluctuations
follow or lag behind, in point of time, the fluc-
tuations of the speculative group, all have to do

1 Published in book form by the Harvard Economic Serv-
ice; reprinted from The Review of Economic Statistic^,
January and April, 1919.



with business and industrial activity; group C,
consisting of series whose fluctuations lag behind
those of the business group, all have to do with
banking conditions and the money market. The
average of each group of series was then found,
with the result that we obtained an average rep-
resenting speculation, an average representing
business, and an average representing banking,
during the period covered by the charts. In
Chart X curves are shown representing these
three averages, and in this manner an Index of
General Business Conditions was obtained for
the period 1903-14. The relationships which
obtained between the three curves representing
speculation, business and banking, during the
pre-war period, are evident from the chart, the
most significant for the purposes of forecasting
being the order in time of the major movements.
These relationships are the basis for our inter-
pretation of the current Index Chart, which
shows the conditions that have existed since the
armistice.

For the period 1914-18 the Great War and
government control of industry dislocated eco-
nomic conditions to such an extent that the nor-
mal relations between speculation, business, and
banking, which the Index shows to have obtained
in time of peace, no longer existed ; the chart for
the war period is, therefore, not presented. The
current Index, however, for the period since the
armistice — based necessarily on somewhat dif-
ferent statistical series from those originally
utilized for the pre-war period — shows that the
normal pre-war sequences between speculation,
business, and banking have been resumed. Fore-
casts of business conditions may, therefore,
safely be made from the current Index of General
Business Conditions, on the basis of conclusions
drawn from pre-war relationships.

When the task of constructing the Index for
the period 1918-22 was undertaken it was found
that current figures for the statistical series
utilized for the pre-war period were not all avail-
able and suitable. Consequently, as has been
said, the current Index is based upon somewhat
different data from those originally utilized for
the period 1903-14. In order to demonstrate
graphically the essential similarity of the data
underlying the current Index Chart and that for
1903-14, we have reconstructed the chart for the
earlier period using the identical series which



8 INTERPRETATION OF THE INDEX OF GENERAL BUSINESS CONDITIONS



CHART XI. —THE INDEX OF GENERAL BUSINESS CONDITIONS, 1903-14
(A) Speculation (B) Business (C) Money



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Explanation: This chart is based upon precisely the same statistical series
as those used in the current Index, given on the opposite page. The curves
are not so smooth as those of Chart X because, first, a smaller number of



enter the current chart. The indices thus se-
cured are given in Chart XI. The curves of this
chart show minor fluctuations which the earlier
chart did not — due to use of monthly data
instead of bi-monthly and fewer series — but the
outstanding movements are the same.

In both the pre-war and post-war periods the
major movements of curve A, speculation, pre-
ceded and hence forecast the movements of curve
B, representing business. Likewise, the major
movements of curve B preceded and, in turn,
forecast those of curve C, representing money.

The Index Chart shows clearly five recurrent
phases in the business cycle, each phase occurring
three times in the period from 1903 to 1914. The
five phases are: (1) depression, (2) revival, (3)
business prosperity, (4) financial strain and
liquidation of securities, and (5) industrial crisis
and liquidation of commodities. Each phase
develops gradually into the one following, but
each, nevertheless, is distinguished by charac-
teristic movements of speculation, of business,
and of money. The Index Chart, through the
movements of the three curves, reveals the phase
of the business cycles existing at any time and,
properly interpreted, forecasts the phase in
prospect.

III. INTERPRETATION OF THE
INDEX

Various generalizations have been made by
students of business fluctuations as to the length



series was averaged in each group and, second, the items are monthly in-
stead of bimonthly.



and regularity of the interval between economic
crises or between business depressions. The
generalization which has received the widest
currency is that crises occur at 10-year intervals.
The proponents of the 10-year theory cite, in
support of their case, the crises of 1837, 1847,
1857, and, after the Civil War in the United
States, those of 1873, 1884, 1893, and 1903.
Another generalization is that crises, especially
those of the last 25 or 30 years, have occurred
regularly at 7-year intervals; thus, it is pointed
out, crises came in Europe in 1893, 1900, 1907,
1914, and 1921. It will be observed that, com-
paring the dates given in support of these two
theories, there is obviously a conflict in the evi-
dence offered. Although it is clear that there are
business cycles with recurrent phases of pros-
perity and depression, it has not been proved that
such cycles are of uniform duration.

One of the most striking and significant things
brought out by our Index Chart for 1903-14 is
the relatively short interval from prosperity to
prosperity, or depression to depression. Basing
our calculations on curve B, representing busi-
ness, we find an interval of somewhat less than
four years from the trough of the depression of
1904 to the trough of the succeeding depression
of 1908, and intervals between the depressions
of 1908, 191 1, and 1 9 14 of about three years
each.

Evidence concerning the frequency of business
depressions, consistent with that of the Index



INTERPRETATION OF THE INDEX OF GENERAL BUSINESS CONDITIONS 9



Chart XII. — The Current Index, 1918-22



1914-18 :
PRCE ^

REVOLUTION

PREVIOUS *1
RELATIONS

AND O

SIGNIFICANCE
OT SERES _
DESTROYED



1918-22:

3EQUENCE

OF

FLUCTUATIONS

RESTORED




1919 1920 1921 1922



Chart, is offered by the course of commodity
prices and interest rates since 1890, shown in the
chart on pages 2 and 3. The intervals between
successive troughs of the wave in the curve for
commodity prices from 1892 to 1914 are, in
months: 34, 26, 44, 44, 43, 43, and 36. The in-
tervals between the troughs in interest rates are
harder to determine, because of the substantial
seasonal influence, but the chart shows that
periods of cheap money occurred in 1892, 1894-
95, 1898, 1900-01, 1904, 1908-09, 191 1, and
1914-15. The evidence of both of these impor-
tant statistical series, and that of the Index Chart,
supports the conclusion that for the twenty-five
years preceding the war, periods of business de-
pression occurred at intervals of approximately
3 or 4 years, with one interval as short as 26
months. 1 In other words, business cycles are of
comparatively short duration. Further, the
lengths of complete cycles in the past, 26 to 44
months, have not been uniform enough to war-
rant predicting the time at which a given phase
of the business cycle will develop, if that predic-
tion must be based upon the assumption of a con-
stunt interval between crises, or between periods of



1 In the post-armistice period it happens that the interval,
shown by curve B of our Index Chart, between the trough of
the short-lived depression of 1919 and the depression of 19 21
(February 1919-May 192 1) is 28 months.



depression. The established sequences of move-
ments of speculation, business and money, how-
ever, afford a method of solving this problem.

The forecasts of the Harvard Economic Service
are not based upon the assumption that the com-
plete business cycle is of invariable length. Nor
are they based upon the distances from the base
line of the three curves of the Index Chart,
representing speculation, business, and money.
Rather, the forecasts are based upon the relations
which exist among those curves during any given
phase of the business cycle and the magnitude of
the movement from crest to trough of each
curve.

In interpreting the Index Chart the points of
primary significance to consider are:


1

Online LibraryWarren Milton PersonsInterpretation of the Index of general business conditions → online text (page 1 of 2)