The Federal Reserve Bank of Chicago economic research department calculates an index of economic activity known as the Chicago Fed National Activity Index (CFNAI). The CFNAI is a weighted average of 85 existing monthly indicators of economic activity drawn from five broad categories: 1) output and income 2) employment, unemployment and hours 3) personal consumption, housing starts and sales 4) manufacturing and trade sales and 5) inventories and orders. This index is constructed to have an average value of zero and a standard deviation of one. Since economic activity tends toward trend growth rate over time, a positive index corresponds to growth above trend and a negative index corresponds to growth below trend. The preferred way to look at the CFNAI is on a 3-month moving average basis. The 3-month moving average of this index in January was minus 0.29, suggesting that the pace of economic activity was below trend. In fact, January marks the fifth consecutive month in which the 3-month moving average of the CFNAI has indicated below trend economic growth (see Chart 1). The CFNAI edged into negative territory in September 2005 because of the disruption of economic activity from Hurricane Katrina. The last time the CFNAI was consistently in negative territory was 2001 through 2003, when real GDP growth was, for the most part, below 3%.

Chart 1

How well does the CFNAI correlate with real GDP growth? Chart 2 suggests "pretty well." The correlation between the quarterly average CFNAI, advanced by one quarter, and the year-over-year percent change in real GDP is 0.81 out of a possible 1.00 - not bad for Fed work.

Chart 2

How well does the CFNAI predict the directional behavior of the federal funds rate? Not as well as it does real GDP growth, but still pretty well, all things considered. The correlation between the quarterly average CFNAI, advanced three quarters, and the year-over-year percentage point change in the federal funds rate is 0.68 (see Chart 3).

Chart 3

Although Chicago Fed President Moskow keeps threatening to vote to raise the federal funds rate, by the time he retires in August, his successor will be supporting cuts in the federal funds rate - cuts presaged by the index, CFNAI, whose derivation and calculation were funded by none other than Chicago Fed President Moskow. It is beyond me why ultimate taxpayer dollars are used by the Federal Reserve System to conduct economic research and that research is routinely ignored in policy making.