This article discusses an experimental methodology for the Chicago Fed National Activity Index—a monthly index designed to gauge overall economic activity and inflationary pressure. The goal is to see how well it accounts for recent structural changes in the U.S. economy.Chicago Fed National Activity Index (CFNAI) ; Economic conditions

Scott Brave

English

Research Papers in Economics

Economic trends and the Chicago Fed National Activity Index
by Scott Brave, senior associate economist
This article discusses an experimental methodology for the Chicago Fed National Activity 
Index—a monthly index designed to gauge overall economic activity and inflationary 
pressure. The goal is to see how well it accounts for recent structural changes in the 
U.S. economy.
Chicag  o Fed Letter
ESSAYS ON ISSUES                                               THE FEDERAL RESERVE BANK                          MAY 2008                                                                  
               OF CHICAGO                                                          NUMBER 250
1. CFNAI, difference between methodologies
NOTE: CFNAI means Chicago Fed National Activity Index.
index
1967 ’72 ’77 ’82 ’87 ’92 ’97 2002 ’07
–0.3
–0.2
–0.1
0
0.1
0.2
0.3
Current CFNAI minus experimental CFNAI 
Mean: 0.00
Median: –0.02
Standard deviation: 0.11
The Chicago Fed National Activity Index 
(CFNAI) is a monthly index of U.S. 
economic activity constructed to sum-
marize variation in 85 data series classi-
ﬁ  ed into four groups: production and 
income; personal 
consumption and 
housing; employment, 
unemployment, and 
hours; and sales, or-
ders, and inventories.1 
Recent structural 
changes in several sec-
tors of the U.S. econo-
my raise the possibility 
that the current index 
methodology is not 
reﬂ  ecting the recent 
contributions of its in-
dividual series to aver-
age economic growth 
as accurately as my 
colleagues and I at the 
Chicago Fed would 
like. In this Chicago Fed 
Letter, I examine this 
prospect and report the 
results of an experi-
mental estimation methodology to 
account for these concerns. I ﬁ  nd that, 
on average, over the full sample period, 
1967–2007, the difference between the 
two CFNAI methodologies is small, but 
varies substantially during shorter peri-
ods of time (see ﬁ  gure 1).
Current methodology
The CFNAI is an example of a 
“Goldilocks” index—a term often used 
in the popular press. In essence, this 
means that the information in various 
data series on national economic activity 
is combined in a way to reﬂ  ect deviations 
around a trend rate of economic growth. 
Accordingly, the CFNAI is normalized 
to have a mean of zero and standard 
deviation of one. In the Goldilocks ter-
minology, this means that a zero value 
of the index is “just right” in that the 
economy is proceeding along its his-
torical growth path. A negative value 
of the index is “cold” in that growth is 
below average, while a positive value is 
“hot” in that it is above average. 
The CFNAI can be very volatile, as many 
of the monthly series that make up the 
index vary signiﬁ  cantly from month to 
month. For this reason, the focus is often 
given to the three-month moving aver-
age of the index, i.e., the CFNAI-MA3, 
which smoothes these month-to-month 
variations over time in order to provide 
a more consistent picture of variations 
in economic growth around trend. 
When the value of this index reaches 
certain levels that have been identiﬁ  ed 
in previous research as “too hot,” the 
likelihood of an inﬂ  ationary period rises; 
when it gets “too cold,” the likelihood 
of a recession rises.2. CFNAI-MA3 and business cycles
NOTES: CFNAI-MA3 is the Chicago Fed National Activity Index’s three-month moving 
average. Shading indicates ofﬁ  cial periods of recession as identiﬁ  ed by the National 
Bureau of Economic Research. A CFNAI-MA3 value below –0.70 following a period 
of economic expansion indicates an increasing likelihood that a recession has begun. 
A CFNAI-MA3 value above +0.20 following a period of economic contraction indicates 
a signiﬁ  cant likelihood that a recession has ended.
index
1967 ’72 ’77 ’82 ’87 ’92 ’97 2002 ’07
–6
–4
–2
0
2
4
Current CFNAI-MA3
Experimental CFNAI-MA3
+0.2
–0.7
3. CFNAI-MA3 and inﬂ  ation cycles
NOTES: CFNAI-MA3 is the Chicago Fed National Activity Index’s three-month moving 
average. Shading represents periods of substantial inﬂ  ation increases. A CFNAI-MA3 
value above +0.70 more than two years into an economic expansion indicates an increasing 
likelihood that a period of sustained increasing inﬂ  ation has begun. A CFNAI-MA3 value 
above +1.00 more than two years into an economic expansion indicates a substantial 
likelihood that a period of sustained increasing inﬂ  ation has begun.
index
1967 ’72 ’77 ’82 ’87 ’92 ’97 2002 ’07
–6
–4
–2
0
2
4
Current CFNAI-MA3
Experimental CFNAI-MA3
+1.0
+0.7
Potential problems with the index
Clearly, for a zero value of the CFNAI 
to accurately depict trend growth, the 
average rates of growth in the underlying 
series must be accurately accounted for. 
For instance, a failure to adjust for a 
change in the average growth rate of a 
signiﬁ  cant number of series can cloud 
the meaning of the CFNAI-MA3, as the 
level of the index will 
be biased by the degree 
to which one under- 
or overestimates the 
level of trend growth. 
Every series in the 
CFNAI has been trans-
formed in such a way 
as to remove previously 
identiﬁ  ed trends; how-
ever, the nature of a 
growing economy is 
such that the emer-
gence of new trends 
is highly probable. 
These changes occur 
over a considerable 
amount of time, and it 
can often take even 
longer before there 
exists sufﬁ  cient evi-
dence to conﬁ  rm 
them. Therefore, the 
CFNAI methodology 
must be periodically 
reexamined to keep it 
in line with changing 
economic conditions. 
Here, I point out two 
issues that may be af-
fecting the calculation 
of the index.
Recent research has 
shown the emergence 
of several aspects of 
structural change in 
U.S. labor markets. 
This effect has poten-
tially ﬁ  ltered into the 
CFNAI through the 
payroll survey of estab-
lishments, which is 
the source of many of 
the employment indi-
cators that are used. 
While it was common 
to see monthly gains 
in nonfarm payroll employment exceed 
150,000 during the late 1990s, recent 
gains are on average much smaller, i.e., 
around 100,000. Instead of signaling a 
decline in labor markets, economists 
have noted that lower trend growth in 
employment may be a reﬂ  ection of chang-
ing labor force demographics and steadily 
declining labor force participation rates 
over the decade.2 Similarly, the boom in 
residential investment during much of 
the previous decade has ended, and con-
struction has declined substantially since 
early 2006. This fact is most readily ap-
parent in the housing starts and permits 
data that underlie the consumption and 
housing category of indicators in the 
CFNAI, as both of these series are demon-
strating average rates of growth that are 
much lower than in the previous decade. 
An experimental methodology
To investigate the degree of potential bias 
in the CFNAI due to these two issues, I 
recently conducted a test of the method 
used to remove trends from the under-
lying data series. Currently, a previously 
identiﬁ  ed stationary transformation is 
applied to each series. Then, each series 
is normalized by subtracting its mean 
and dividing by its standard deviation, 
where these statistics are calculated using 
the entire sample of available data.3 As 
an example, for nonfarm payroll employ-
ment, the ﬁ  rst difference of the natural 
log transformation is initially applied, 
and next the series is normalized by its 
sample mean and standard deviation. 
The test I conducted centered on the use 
of a 120-month moving average normal-
ization for each transformed series. That 
is, for each month in my sample I nor-
malized every transformed series by sub-
tracting its mean calculated using only the 
data for the prior 120 months and di-
viding by the standard deviation of the 
resulting series. The advantage of nor-
malizing each series in such a way is that, 
contrary to the current method, it allows 
for very slow moving changes in trend 
growth, i.e., around a decade in length. 
I chose a decade as the time reference to 
reﬂ  ect the approximate average length 
of a business cycle during the period 
for which the CFNAI is calculated. 
I performed this exercise for each of 
the four categories of indicators that 
make up the index, using the data avail-
able for the December 2007 CFNAI 
(released in January 2008). From March 
1967 through December 2007, I observe 
small differences in each category be-
tween the current and experimental 
methodologies. On average, the differ-
ence between the current method and Charles L. Evans, President; Daniel G. Sullivan, 
Senior Vice President and Director of Research; Douglas 
Evanoff, Vice President, ﬁ  nancial studies; Jonas Fisher, 
Economic Advisor and Team Leader, macroeconomic 
policy research; Richard Porter, Vice President, payment 
studies; Daniel Aaronson, Economic Advisor and 
Team Leader, microeconomic policy research; William 
Testa, Vice President, regional programs, and Economics 
Editor; Helen O’D. Koshy, Kathryn Moran, and 
Han Y. Choi, Editors; Rita Molloy and Julia Baker, 
Production Editors.  
Chicago Fed Letter is published monthly by the 
Research Department of the Federal Reserve 
Bank of Chicago. The views expressed are the 
authors’ and are not necessarily those of the 
Federal Reserve Bank of Chicago or the Federal 
Reserve System. 
© 2008 Federal Reserve Bank of Chicago 
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ISSN 0895-0164
4. Recent CFNAI-MA3 and relevant thresholds
NOTES: CFNAI-MA3 is the Chicago Fed National Activity Index’s three-month moving 
average. A CFNAI-MA3 value below –0.70 following a period of economic expansion 
indicates an increasing likelihood that a recession has begun. A CFNAI-MA3 value 
above +0.20 following a period of economic contraction indicates a signiﬁ  cant likelihood 
that a recession has ended. A CFNAI-MA3 value above +0.70 more than two years 
into an economic expansion indicates an increasing likelihood that a period of sustained 
increasing inﬂ  ation has begun. A CFNAI-MA3 value above +1.00 more than two years into 
an economic expansion indicates a substantial likelihood that a period of sustained 
increasing inﬂ  ation has begun.
index
2000 ’01 ’02 ’03 ’04 ’05 ’06 ’07
–1.5
–1.0
–0.5
0.0
0.5
1.0
1.5
Current CFNAI-MA3
Experimental CFNAI-MA3
+0.7
–0.7
+0.2
+1.0
the 120-month moving average method 
is essentially zero for consumption and 
housing; 0.01 for production and income; 
0.01 for sales, orders, and inventories; 
and 0.02 for employment, unemploy-
ment, and hours. Variation around these 
means is also limited, as the standard 
deviations are 0.02 for sales, orders, and 
inventories; 0.03 for production and 
income; 0.04 for consumption and hous-
ing; and 0.05 for employment, unem-
ployment, and hours. 
However, the story changes for shorter 
time periods. For instance, focusing on 
recent data, I ﬁ  nd that the current meth-
odology consistently calculates lower 
values for employment-related indicators 
and higher values for housing-related 
indicators since 2003. In contrast, I ﬁ  nd 
very little difference in the other cate-
gories during this period. This result 
offers some evidence of structural change 
in labor and housing markets over the 
last two decades, as historical trend rates 
of growth appear to have ﬂ  uctuated in 
the series that are used to capture these 
sectors of the economy. 
The CFNAI is a weighted average of the 
values of each category of indicators. 
Not surprisingly, then, when I compare 
the CFNAI by method-
ology, I do not ﬁ  nd 
large discrepancies 
between the two meth-
ods. Over the entire 
sample period, the av-
erage difference be-
tween the current and 
experimental methods 
for the CFNAI is essen-
tially zero, while the 
standard deviation is 
only 11% of the index’s 
constructed standard 
deviation. However, as 
ﬁ  gure 1 demonstrates, 
over shorter time pe-
riods the differences 
are more substantial. 
For instance, the 
“Great Moderation” is 
visibly evident as the two 
methodologies diverge 
during the late 1970s 
and early 1980s, when 
substantial structural 
changes occurred across multiple sectors 
of the U.S. economy.4 More recent values 
of the CFNAI also have begun to differ 
substantially, as the differences I observe 
between methodologies for employment-
related indicators have become greater 
than those for housing-related indicators. 
At this level of discrepancy, the choice of 
methodology is unlikely to seriously alter 
the interpretation of the CFNAI-MA3. 
In fact, I ﬁ  nd insigniﬁ  cant differences 
between the two methods in identify-
ing recessions and inﬂ  ationary periods 
using the CFNAI-MA3 as shown in ﬁ  g-
ures 2 and 3, respectively. Previous re-
search has indicated that CFNAI-MA3 
values less than or equal to –0.7 after a 
period of economic expansion often 
coincide with recession periods as 
identiﬁ  ed by the National Bureau of 
Economic Research.5 I ﬁ  nd that both 
methods are nearly equally predictive 
in identifying recessions in this fashion. 
The same is true for the +0.2 value that 
serves as a signal for the end of a reces-
sion. Similarly, previous research has 
shown that inﬂ  ationary periods often 
coincide with values greater than or 
equal to +0.7 more than two years into 
an economic expansion.6 Here, once 
again, both methods are nearly equally 
predictive in identifying these periods, as 
well as high-risk inﬂ  ation periods asso-
ciated with values greater than or equal 
to +1.0. 
During the past decade, we have 
approached both the recession and 
inﬂ  ation thresholds, offering a good 
opportunity to critique the most recent 
interpretations of the index. Figure 4 
shows the CFNAI-MA3 since January 
2000. Under the current methodology, 
the CFNAI-MA3 crossed the inﬂ  ation 
threshold of +0.7 in December 2005, 
only to return below it in the following 
month. Under the experimental meth-
odology, the CFNAI-MA3 remained 
above this threshold for two consecutive 
months. Thus, the experimental meth-
odology would have placed a slightly 
higher level of concern on a potential 
rise in inﬂ  ationary pressures from eco-
nomic activity during 2006, but not 
much more than the current method. 
In terms of recessions, both the current 
and experimental CFNAI-MA3 correctly 
indicated the 2001 recession. However, 
under the current methodology, the index 
failed to achieve the +0.2 threshold level 
immediately following the 2001 recession. 
Instead, it brieﬂ  y returned below the re-
cession threshold of –0.7 in April and 1 Additional background information on 
the construction of the CFNAI can be 
found at www.chicagofed.org/cfnai.
2 Riccardo DiCecio, Kristie M. Engemann, 
Michael T. Owyang, and Christopher H. 
Wheeler, 2008, “Changing trends in the 
labor force: A survey,” Review, Federal 
Reserve Bank of St. Louis, Vol. 90, No. 1, 
January/February, pp. 47–62; Daniel 
Aaronson, Kyung-Hong Park, and Daniel 
Sullivan, 2006, “The decline in teen labor 
force participation,” Economic Perspectives, 
Federal Reserve Bank of Chicago, Vol. 30, 
No. 1, First Quarter, pp. 2–18.
3 See the technical report at 
www.chicagofed.org/cfnai for more de-
tailed information on the current con-
struction of the CFNAI.
4 The Great Moderation is a recent economic 
phenomenon—from approximately 1980 
to the present—when volatility dramatically 
decreased for changes in economic activity, 
consumption, and inﬂ  ation.
5 Charles L. Evans, Chin Te Liu, and 
Genevieve Pham-Kanter, 2002, “The 2001 
recession and the Chicago Fed National 
Activity Index: Identifying business cycle 
turning points,” Economic Perspectives, 
Federal Reserve Bank of Chicago, Vol. 26, 
No. 3, Third Quarter, pp. 26–43. 
6 Jonas D. M. Fisher, 2000, “Forecasting 
inﬂ  ation with a lot of data,” Chicago Fed 
Letter, Federal Reserve Bank of Chicago, 
No. 151, March.
May of 2003, signaling a prolonged slug-
gish recovery that in fact occurred. This 
same type of signal was observed following 
the 1990–91 recession in December 1991 
and January 1992, and has come to be 
associated with a slower recovery period 
than past recessions, particularly in the 
labor market, i.e., a “jobless recovery.” 
Using the experimental methodology, 
only April 2003 was below this thresh-
old, suggesting very slight differences 
between the methods in the predicted 
recovery time for the 2001 recession and 
its most recent predecessor.
The current methodology also showed 
CFNAI-MA3 values in October and 
December of 2007 that were roughly 
0.03 above the recession threshold of –0.7, 
suggesting that a recession was becoming 
more likely. However, after adjusting for 
changes in trends in labor and housing 
markets, the experimental methodology 
was roughly 0.17 from this threshold in 
those months, suggesting less concern. 
In this respect, the current period dem-
onstrates that during times of changing 
trends, the methodology used to inter-
pret the index may matter more. Recently 
weak employment and housing numbers 
that are currently driving the index appear 
to have very different effects depending 
on how these changing trends are ac-
counted for. Therefore, it may be impor-
tant to keep in mind these differences 
over the coming year when interpreting 
the CFNAI-MA3.
Conclusion
I ﬁ  nd some evidence that recent struc-
tural changes in labor and housing mar-
kets are currently making an impact on 
the calculation of the CFNAI and the 
interpretation of the CFNAI-MA3. In 
spite of this fact, the historical interpreta-
tion of the overall index remains very 
similar under both the experimental 
method for dealing with this problem and 
the current methodology. The thresholds 
currently used to indicate the likelihood 
of a recession or sustained inﬂ  ationary 
period apply equally well to each meth-
odology. However, as recent values of the 
index indicate, during periods of struc-
tural change the differences between 
methodologies can be substantial enough 
to alter these inferences. For this reason, 
my colleagues and I at the Chicago Fed 
will continue to monitor the behavior of 
the index and its component series in 
order to determine whether it will be 
necessary to change the CFNAI method-
ology to preserve the usefulness of the 
index as a cyclical indicator. 

Economic trends and the Chicago Fed National Activity Index

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