An evaluation of business survey indices for short-term forecasting: Balance method versus Carlson-Parkin method

When questions in business surveys about the direction of change have three reply options, “up”, “down”, and “unchanged”, a common practice is to release the results as balance indices. These are linear combinations of the response shares, i.e., the percentage share of the respondents who answered “up” minus the percentage share of those who answered “down”. Forecasters traditionally use these indices for short-term business cycle forecasting. Survey response shares can also be combined non-linearly into alternative indices, using the Carlson-Parkin method. Using IFO and ISM data, this paper tests the relative performance of Carlson-Parkin type indices versus balance indices for the short-term forecasting of industrial production growth. The main finding is that the two types of indices show no difference in forecasting performance during the Great Moderation. However, the Carlson-Parkin type indices outperform the balance indices during periods with higher output volatilities, such as before and after the Great Moderation.