Pierce County Economic Index The Development, Construction, and Evaluation of a Local Forecasting Model

1. Pierce County Economic IndexThe Development, Construction, and Evaluation of a Local Forecasting Model Douglas Goodman Bruce Mann University of Puget Sound Department of Economics

2. Support on Getting Started1985 - 1986 Tacoma Pierce County Chamber of Commerce University of Puget Sound School of Business • Local Business Community • Tacoma Public Utility • Port of Tacoma • Frank Russell • The News Tribune • Key Bank (Puget Sound National) • Washington Natural Gas

3. Forecasting for Pierce CountyWhat We Knew NOTHING

4. First Steps:What We Had To Do • Find a measure of local aggregate output • Find the time trend in the measure • Determine what variables explained the trend • Develop forecasting model

5. Measure of Local Output • Output not observable or measurable • Well-being used instead, proxied by • Income • Retail Sales • Employment • Housing • Trade

6. Survey Data Business Leaders Government Officials Academics Data Exploration Income Employment Unemployment Sales Find the Trend Determined a trend and pattern consistent with both methods and typical of business cycle behavior

7. Variables To Explain Trend • Economic Base Model: Income a function of exogenous spending • Basic Sectors • Importance of Sectors • Shift-Share Analysis: Sector Importance • Role of Sectors • Contribution to Local Performance

8. Variables: First CutLabor Market • Population receiving unemployment insurance • Population moving off unemployment insurance • Non-agricultural employment • Manufacturing employment • Residential civilian labor force • Unemployment rate • Want-Ad advertising

9. Variables: First CutSector Activity • Contract construction employment • Number of retail establishments • Taxable retail sales • Number of manufacturing establishments • Taxable manufacturing sales • Commercial building permits issued • Value of softwood log exports • Quantity of softwood lumber of exports

10. Variables: First CutHousing Activity • New home utility hook-ups • New apartment utility hook-ups • New housing sales listings • Unsold housing inventory

11. Variables: First CutWealth and Income • Local stock index • Interest rate • Deposits at area banks • Per capita income

12. Variables: First CutNational Factors • Consumer price index • Real gross national product • National defense expenditures • Trade weighted value of the U.S. dollar • Nominal M2 money supply

13. Creating the IndexStep One Variable selection based on: Existence, frequency, and consistency • Based on the subjective survey results • and known values for income: • Created an index measure that replicated the pattern • Explored the relationship of the independent variables to index • Lag structures • Interaction possibilities • Nonlinearities • Reduced data set to significant and plausible variables • Tested the model for 1976 through 1987

14. Creating the IndexStep Two Data Reduction • Redundancy • High collinearity • Non-significance Data Consolidation • Principal Component: Factor Analysis • Three factors maintained 85%+ of variance • General Economic Forces • Labor Market Conditions • Unique Local Effect

15. Revising the ModelStep Three • Problems • Cost and Time • Disappearing Data Series • Changed Economic Structure • Redefined Model Structure • Reduced Variable Selection • Simplified Specification

16. Current Model Structure Pierce County Economic Index a function of: • Labor Market Conditions Index – Nonagricultural Employment and Civilian Labor Force • Northwest Stock Index – Davidson 99 • Real Gross Domestic Product • Treasury Bond Three Year Interest Rate - Current • Treasury Bond Three Year Interest Rate - Lagged One Period • Contract Construction • Structural Shift Dummy for 1990 All variables, except dummy for structural shift, are four quarter moving averages

17. Pierce County Economic Index Quarterly Values Actual = 20.04+ .91* Forecast R2 = .70 (t) (1.41) (9.89) F = 97.9 (p = .00)

18. Pierce County Economic Index Annual Values Actual = -22.20 + 1.18* Forecast R2 = .98 (t) (2.61) (21.45) F = 460.1 (p = .00)

19. Pierce County Economic Index Quarterly Percent Change Actual = 1.98 + .44* Forecast R2 = .14 (t) (3.75) (2.56) F = 6.57 (p = .01)

20. Pierce County Economic Index Annual Percent Change Actual = 1.17 + 0.51* Forecast R2 = .21 (t) (1.14) (1.54) F = 2.37 (p = .15)

21. Total and Per Capita Personal Income and Pierce County Economic IndexAnnual Percent Change

22. Directional Accuracy From 1997:1 to 2007:4 – 43 Quarterly Changes • Correct Predictions = 60% (26 of 43) • Growth Rate Increasing = 65% (13 of 20) • Growth Rate Declining = 57% (13 of 23) Of the 13 Quarters Incorrectly Predicted • 2 – Three Quarter Runs • 2 – Two Quarter Runs • 7 –One Quarter Runs

23. Nonagricultural Employment Quarterly Percent Change Actual = .62 + .61* Forecast R2 = .28 (t) (1.77) (4.06) F = 16.5 (p = .00)

24. Nonagricultural Employment Annual Percent Change Actual = 0.36 + .81* Forecast R2 = .48 (t) (.57) (2.88) F = 16.5 (p = .00)

25. Unemployment Rate Quarterly Percent Change Actual = -.82 + 1.12* Forecast R2 = .85 (t) (1.77) (4.06) F = 105.7 (p = .00)

26. Unemployment Rate Annual Percent Change Actual = -0.91 +1.14* Forecast R2 = .77 (t) (.75) (5.52) F = 30.4 (p = .0)

27. Taxable Retail Sales Quarterly Percent Change Actual = 7.45 - .17* Forecast R2 = .01 (t) (4.94) (.62) F = .39 (p = .54)

28. Taxable Retail Sales Annual Percent Change Actual = 9.32 - .53* Forecast R2 = .15 (t) (4.12) (1.28) F = 1.63 (p = .23)

29. Conclusions • Inherent Problems • High degree of openness and exogeniety • Data reliability and consistency • Structural change monitoring • Turning point prediction most problematic • Model Design and Development • Can be efficient and effective • Internal structure crucial • Judgmental adjustments essential