Using financial indicators to predict turning points in the business cycle: The case of the leading economic index for the United States

In this paper, we evaluate the usefulness of financial indicators according to their ability to predict recessions (i.e., peaks in the business cycle). We then select a small set of financial indicators to aggregate into a single composite index of financial indicators, which we name the Leading Credit Index (LCI). Our approach differs from others in the literature in that we follow the composite index approach of the Leading Economic Index (LEI) of the United States and focus on a small, carefully selected set of indicators as index components, and, in addition, our selection criteria target business cycle turning points rather than financial stress or instability. We show that this leading credit index, either alone or as a component of the LEI, can be helpful in estimating recession probabilities, which it does better than the individual indicators, including some of the existing components of the LEI, especially real money supply.