The Cabinet

Information and Decision Support Centre

Economic Analysis Sector

Indicators of Business Cycle Activity in Egypt

Prepared by

Mohamed Abdel-Ghany Ramadan

August 2005
Indicators of Business Cycle Activity in Egypt 2

Abstract
Since its liberalization, academicians and decision makers have presumed that the
Egyptian economy is cyclically subjected to phases of expansion and contraction. So far, to
the best of one's knowledge, nobody has been able to formally pinpoint these business cycle
phases or to date the boom and the recessionary cyclical turning points for the case of Egypt.
In this study, the Generalized Dynamic Factor Model (GDFM) is employed to formally
estimate a set of leading and coincident business cycle indexes (BCIs), which correspond to
both classical and deviations cycles. Twenty key macroeconomic indicator variables are used
in estimating the indexes during the period 1984-2003. The findings of this study reveal
strong cyclical fluctuations in the behavior of economic activity. Phase analysis is utilized to
classify the indicator variables as pro-cyclical or countercyclical and the Bry-Boschan
algorithm is implemented to identify the cyclical turning points of economic activity. Policy
results are derived from this analysis, particularly to explain the main driving forces of
economic growth in Egypt.

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Indicators of Business Cycle Activity in Egypt 3

Table of Contents
Executive Summary..................................................................................................................4
1. Introduction ..........................................................................................................................6
2. Main objectives .....................................................................................................................7
3. Computing BCIs for Eg ypt 1984-2003 ..............................................................................8
4. Turning Points Dating for BCI Estimates........................................................................18
5. Conclusion ...........................................................................................................................22
References ...............................................................................................................................24
Indicators of Business Cycle Activity in Egypt 4

Executive Summary

Business cycle indicators have proven to be useful tools for analyzing alternating
sequences of economic expansions and contractions known as business cycles. Mitchell and
Burns (1938) originated the indicator approach that made extensive use of business cycle
indicators in the mid-1930s at the National Bureau of Economic Research (NBER). It
explores patterns of economic fluctuation that are defined by “business cycles ... [which]
consist of expansions occurring at about the same time in many economic activities, followed
by similarly general recessions, contractions and revivals which merge into the expansion
phase of the next cycle.” (Burns and Mitchell 1946).
Subsequent work on “Business Cycle Indicators” was conducted by Geoffrey H.
Moore (1961) as Director of Research at the NBER, along with Charlotte Boschan, Gerhard
Bry, Julius Shishkin, Victor Zarnowitz, and others affiliated with the NBER. In 1961, under
the direction of Julius Shiskin at the Bureau of the Census, the U.S. Government began
publication of a monthly report, Business Cycle Developments (BCD). This work was
undertaken in cooperation with the NBER and the President’s Council of Economic Advisers,
and made extensive use of time-series charts of the NBER indicators (80 U.S. series and
indexes of industrial production for seven major trading partners). In 1968, the report was
renamed Business Conditions Digest, and in 1972, the indicators were shifted to another
Commerce Department agency, the Bureau of Economic Analysis (BEA).
In 1995, the BEA decided to concentrate on the National Income and Product
Accounts (NIPA), and transferred its program of research and production of business cycle
indicators to The Conference Board. Since then, The Conference Board has improved the
indexes, developed a Web-based system for their dissemination, and created a program of
research and education on cyclical indicators.
Business cycle indicators are assorted economic statistics that provide valuable
information about the expansions and contractions of business cycles. These statistics are
grouped into three sets--lagging, coincident, and leading. Leading economic indicators tend to
move up or down a few months before business-cycle expansions and contractions.
Coincident economic indicators tend to reach their peaks and troughs at the same time as
business cycles. Lagging economic indicators tend to rise or fall a few months after business-
cycle expansions and contractions.
Business cycle (BC) fluctuations affect the perceptions of decision makers, in both the
business and the government sectors, about the real state of aggregate economic activity and
about the prospects for macroeconomic and political stability. The classical BC literature
mainly observed business cycles in terms of absolute changes, i.e. expansions and
contractions, in the level of some real general measure of economic activity. According to this
approach, the state of economic activity is measured either in terms of a single variable,
typically (real) GDP, or in terms of comovements of selected business cycle variables. In the
latter case, economic activity is described by the common behavior of those variables. This
approach provides the main basis for recent developments in modern business cycle index
(BCI) estimation.
Because BC fluctuations involve intricate dynamical changes in the behavior of
multiple macroeconomic indicators, recent business cycle literature has devoted considerable
attention to the development of formal statistical models to encapsulate these changes in one-
dimensional coincident and leading BCIs that take into account the underlying shocks that
drive the cyclical dynamics. This would necessarily entail an averaging process for a selected
Indicators of Business Cycle Activity in Egypt 5

set of key macroeconomic indicator variables that compose the index and the selection of
appropriate weights for each one of them to be used in the construction of the index. The first
and most widely used is the method that estimates the index as a weighted average of
individual indicators. In that way, modern BCIs are readily capable of portraying changes in
the aggregate performance of the economy by identifying periods of expansions and of
recessions based on comovements of a number of macroeconomic time series. Besides,
several economic theories have focused on examining the movements of variables around a
permanent (trend) component. To accommodate these theories, modern approaches for
deriving BCIs- in contrast with the classical framework- typically involve analyzing a class of
cycles known as deviation (or growth) cycles, which consider fluctuations in economic
activity arising around the trend. Consequently, stationary time series are required for
estimating the growth cycle index.
Since the late 1970s through the 1980s, Egypt has attempted to adopt liberal economic
policies based on encouraging private sector initiatives, as part of the country's endeavors to
raise the levels of activity and productive efficiency in the economy. Meanwhile, the year
1991 witnessed a major turning point in the liberalization process of the Egyptian economy
with initiation of an Economic Reform and Structural Adjustment Program (ERSAP). The
liberalization of the economy has extended the role of market forces and their effect on the
dynamical behavior of a large number of important macroeconomic variables in Egypt, which
began to exhibit significant comovements and changes since the late 1970's. Such complex
changes in different series are typically translated into BC fluctuations in the form of
intermittent phases of up- and downturns in economic activity. It may be convenient,
therefore, to represent these fluctuations by some BCI that is capable of providing a tractable
description of the real cyclical behavior of the economy and of associating the turning points
(i.e. the peaks and the troughs) of the index with relevant facts about the changes in that
behavior. Up until now, to the best of one's knowledge, such an index is not available for
Egypt.
This study comprises five sections including the introduction and the conclusion. With
respect to the second section, that comes under the title of "Main Objectives", it aims at
highlighting the main objective of the study which is: adopting a modern systematic
framework for constructing coincident and leading BCIs that can be utilized to represent the
real cyclical behavior of the aggregate economy and to identify the historical turning points in
Egyptian economic activity. Concerning the third section, with the title of "Computing BCIs
for Egypt 1984-2003", it is concerned with the empirical construction of the coincident and
leading indexes of real economic activity in Egypt during the period 1984-2003 based on the
theoretical GDFM framework. Finally, regarding the fourth section, whose title is "Turning
Points Dating for BCI Estimates", its main goal is to show that BCIs are importantly of use in
identifying the cyclical turning points (peaks and troughs) of the classical and of the deviation
cycles, i.e. of the level and of the growth rate of GDP, respectively. It also shows how the BB
(1971) algorithm is selected for formally dating the turning points of both classical and
growth cycles, the appropriateness of this selection notwithstanding.
Indicators of Business Cycle Activity in Egypt 6

1. Introduction

Business cycle indicators are assorted economic statistics that provide valuable
information about the expansions and contractions of business cycles. These statistics are
grouped into three sets that are lagging, coincident, and leading. Leading economic indicators
tend to move up or down a few months before business cycle expansions and contractions.
Coincident economic indicators tend to reach their peaks and troughs at the same time as
business cycles. Lagging economic indicators tend to rise or fall a few months after business
cycle expansions and contractions. Therefore, the need of this paper raised to adopt a modern
systematic framework for constructing coincident and leading BCIs that can be utilized to
represent the real cyclical behavior of the aggregate economy and to identify the historical
turning points in Egyptian economic activity.
The main goal in this paper is to uncover the cyclical behavior of the economy and the
comovements of selected macroeconomic indicators through the estimation of real BCIs for
Egypt. To meet this goal, the Generalized Dynamic Factor Model (GDFM) has been applied
to estimate the common component coincident index for real economic activity in Egypt
during the period 1984-2003 using annual data on twenty key macroeconomic indicators. In
general, this paper serves two purposes. First, it empirically demonstrates to Egyptian
researchers in a straightforward way how to estimate coincident and leading BCIs of real
economic activity, how to evaluate their performance and how they may be useful for policy
oriented analysis. Second, it provides some formal evidence about the comovements of
important macroeconomic variables and identifies specific periods of real expansions and
contractions in the growth rate and in the overall level of activity. Policy results are derived
from the analysis, particularly to explain the main driving forces of economic growth in
Egypt.
Indicators of Business Cycle Activity in Egypt 7

2. Main objectives

The main objective of this study is to adopt a modern systematic framework for
constructing coincident and leading BCIs that can be utilized to represent the real cyclical
behavior of the aggregate economy and to identify the historical turning points in Egyptian
economic activity1. A recent version that belongs to the class of dynamic factor models is
employed to estimate the BCIs from a dataset encompassing key macroeconomic indicators in
Egypt during the period 1984-2003. In particular, the Generalized Dynamic Factor Model
(GDFM)2 introduced in the seminal studies by Forni, Hallin, Lippi and Reichlin (2000a and
2000b, henceforth Forni et al.) and Forni and Lippi (2001) is applied to compute classical and
growth cycle coincident and leading BCIs for that period. Important cyclical facts,
represented by the turning points of the growth and of the level cycle indexes are examined
using the BCI estimates. Moreover, the study attempts to hold a comparison between the
cyclical turning points of the classical and the deviation cycles- computed using the GDP
level and growth rate series, respectively- with the peaks and troughs of the corresponding
BCIs estimates. In other words, the paper investigates the next hypotheses

1. Does the Egyptian economy experience regular patterns of fluctuations (expansions

and contractions) in economic activity, i.e. BC fluctuations?

2. If it does, can (real) GDP (in level and/or in rate of growth) capture these cyclical
fluctuations?

3. If GDP is indeed capable of capturing cyclical variations in the economy, is it

sufficient by itself for representing all the BC fluctuations?

1
This study is based on an earlier study entitled " Coincident and Leading Indicators of Business and Economic
Activity in Egypt: A Generalized Dynamic-Factor Model Approach" by Moursi, El Mossallamy and Reda
(2005). Unpublished manuscript.
2
For more details Altissimo et al. (2001), Bry and Boschan (1971, henceforth BB), Geweke (1977), Harding and
Pagan (2001), Sargent and Sims (1977) and Stock and Watson (1989).
Indicators of Business Cycle Activity in Egypt 8

3. Computing BCIs for Egypt 1984-2003

This section is concerned with the empirical construction of the coincident and leading
indexes of real economic activity in Egypt during the period 1984-2003 based on the
theoretical GDFM framework. In particular, the four steps of GDFM are applied to compute
the BCIs.
Recall that the initial step requires identifying the appropriate variables to be used in
estimating the indexes. Selecting the variables that might be considered informative in
characterizing cyclical development of real activity in Egypt is a complicated task that
depends to a great extent on the value judgment of the researcher. On one hand, short on ultra-
annual frequency information on almost all real economic variables- including foremost GDP-
the study is practically left only with annual frequency data to depict the BC behavior. On the
other hand, the dearth of reasonably long, reliable and consistent macroeconomic series
considerably limits the opportunity of choosing an adequate number of series, which would be
sufficient to portray BC activity without missing pertinent information.
In this study, it has been decided to depend almost exclusively on the International
Financial Statistics (IFS) (IMF, 2004) annual dataset in order to avoid- as much as possible-
inconsistencies and discrepancies found in macroeconomic data obtained from national
sources. Thus, the number of selected indicators employed in constructing the BCIs depends
both on the amount of information provided in the IMF dataset and on the judgment of the
researcher(s).
Besides real GDP, the database proposed to estimate a GDFM for Egypt consists of
nineteen macroeconomic indicators that are informative in describing the evolution of
business cycle fluctuations in Egypt. They include a handful of key real sector variables in the
economy as well as important indicators for the monetary sector and for the labor market. The
listing of the selected indicator variables along with a brief description is displayed in Table 1.
All the variables in the system, save the unemployment rate, are taken from the IFS (IMF,
2004). The unemployment rate series is obtained from the World Development Indicators
(Word Bank, 2003) and from the National Data Store (IDSC, 2004).
The annual indicators series in the database employed in this study cover the period
from 1984-2003; hence, T = n = 201. As indicated in Table 1, all data are logged and
appropriately differenced to reach stationarity, except for change in inventories, CPI, WHP
and GDPD inflation, 3-month nominal and real deposit rates and nominal and real discount
rates, which are only transformed by differencing. Subsequently, all the indicator series are
normalized via division by their standard deviations.

1
The equality of T and n is accidental and should not have any bearing either on the estimation procedure
adopted in this study or on the results.
Indicators of Business Cycle Activity in Egypt 9

Table 1
Annual Indicators

Variables Description*
1. RGDP Real GDP (deflated by GDP deflator: GDPD) [1]
2. CONS Real private consumption (deflated by consumer price index: CPI) [1]
3. GFI Real gross fixed capital formation (deflated by producer price index: WHP) [1]
4. dNINVT♣ Change in inventories [1]
5. EXP Real exports of goods and services (deflated by GDPD) [1]
6. IMP Real imports of goods and services (deflated by GDPD) [2]
7. RER Real exchange rate (local currency per US $) [1]
8. SCR Real Suez Canal revenues (deflated by GDPD) [2]
9. pCPI♣ CPI inflation [1]
10. pGDPD♣ GDPD inflation [1]
11. pWHP WHP inflation [1]
12. M1 Real money balances (M1) (deflated by CPI) [1]
13 M2 Real money balances (M2) (deflated by CPI) [2]
14. iNDR♣ Discount rate [1]
15. iN3Mo♣ 3-Month deposit rate [2]
16. i3Mo♣ Real interest rate (iN3Mo - pCPI) [1]
17. iDR♣ Real discount rate (iNDR - pCPI) [1]
18. SALES Real sales (deflated by GDPD) [1]
19. UNEMP Unemployment rate [1]
20. GDPUS Real US GDP (deflated by US GDPD) [1]
* Integers in brackets show the number of differences needed for stationarity.
♣ Variables transformed by differencing only.

It has been already indicated that the choice of macroeconomic indicators used in
estimation depends considerably on the value judgment of the researcher(s). It is stipulated
that, save US real GDP, the remaining macroeconomic variables, listed in Table 1, can
capture relevant facts- particularly the turning points- that describe business cycle fluctuations
in Egypt during the period under consideration. In contrast, it is believed that US GDP should
provide a good indication of the influence of changes in the global economy on domestic
expansions and contractions in economic activity. Despite the short period under
consideration, some Granger causality tests are conducted to examine the relation between the
selected BC indexes and GDP growth, which is taken to represent deviation cycle
fluctuations. The tests (results not reported) reveal that five of the nineteen indictors- namely
gross fixed capital formation, change in inventories, imports, unemployment and US GDP
Granger cause real GDP.
Employing the Forni et al. (2000a and 2000b) methodology, the GDFM is estimated
for Egypt. The estimation produces the common component coincident indexes series of the
twenty selected variables that describe the cyclic behavior of the economy. However, because
the data do not support a single common factor, the cycle must be defined in terms of an
individual common component coincident index. In theory, it is presumed that the common
component coincident index series of real GDP is the most likely candidate for the reference
variable. As will be seen below, the estimation output provides persuasive ex post
justification for that choice.
Indicators of Business Cycle Activity in Egypt 10

Table 2
Variance Explained by the Common Component Coincident indexes
and Average Contemporaneous Correlation of Common Component
Coincident index with those of the Other Variables

Variance Explained (%) Average Correlation (%)

RGDP 90.775 11.763
CONS 94.528 3.169
GFI 84.149 6.097
dNINVT 89.769 5.753
EXP 91.756 5.179
IMP 91.254 -1.978
SALES 88.344 5.050
SCR 89.969 3.970
RER 95.411 2.805
pCPI 94.401 -4.343
pGDPD 90.392 7.836
pWHP 90.643 -0.168
M1 80.593 2.118
M2 93.236 4.896
iN3Mo 87.074 -2.167
i3Mo 90.812 -6.317
iNDR 87.953 -4.218
iDR 91.433 2.391
UNEMP 88.112 0.734
GDPUS 77.428 -2.831

The first column in Table 2 exhibits the percentage variance ratio between each
variable's common component coincident index and its total, which measures the degree of
commonality of each variable in the model. In addition, the second column in the table
presents for each variable the average contemporaneous correlation coefficient with the
common component coincident index of the other variables, which measures the degree of
synchronization of each variable with the other variables (Forni et al., 2000a). Several
deductions come out of these statistics.
The first column of the table reveals that the variance explained by RGDP is relatively
low. This implies that using real GDP rather than the common component coincident index of
GDP as the reference BCI series is not a good choice because a substantial portion of RGDP
(i.e. the relatively large idiosyncratic component that explains more than 9 percent of total
variance) is poorly correlated with other variables in the economy. Such finding sends an
unambiguous message of caution to public policy makers who may inadvertently rely solely
upon GDP and its variation to describe the dynamics of business activity and to provide
information about the level of performance in the economy.
Conversely, the common component coincident index of RGDP has the largest degree
of synchronization (11.8 percent) with the other indicator variables in the system. This high
contemporaneous correlation provides strong ex post validation for selecting the common
component coincident index of GDP as the reference series to describe the cyclical economic
behavior of the Egyptian economy.
Indicators of Business Cycle Activity in Egypt 11

Figure 1
A B

Looking at the variance ratios in the first column of Table 2, it is observed that some
variables, particularly real exchange rate, exports and imports as well as consumption, M2 and
CPI inflation on average exhibit a relatively large degree of commonality with the other
variables in the system. However, the degree of synchronization of these indicators with the
other variables is significantly low in comparison with RGDP. Actually, on the extreme side,
both CPI inflation and imports show evidence of negative synchronization with the other
variables. Consequently, it appears that these and the other indicators, with the exception of
RGDP, could not be considered good coincident BCIs. The results suggest employing the
common component (CC) coincident index of GDP (∆CCIt), which is plotted in Figure 1-A
together with RGDP growth, as the reference indicator. Moreover, Figure 1-B portrays real
GDP and the common component coincident index series after transforming them back into
levels by restoring the time trend. Both reference series, in level and in growth rate, should be
useful later on in the examination of cyclical turning points according to the classical and the
growth cycles, respectively.
Following Forni et al., (2000b), it has been seen earlier that it is possible to establish
whether each indicator variable is coincident, leading or lagging the common component
coincident index from the estimates of the contemporaneous and lagged cross-covariances
between the common component of each variable and the common component coincident
index. Table 3 shows the classification of the selected indicator variables as coincident,
leading or lagging depending on an analysis of the time phase lead of each variable with
respect to the RGDP common component coincident index. In the analysis, it is assumed that
the leading variables are those which have a time phase lead that exceeds one quarter, and the
lagging variables are those which have a time phase lag that exceeds one quarter. Variables
that are neither leading nor lagging are assumed coincident. Variables that are in phase with
respect to the RGDP common component coincident index are considered pro-cyclical while
those that are out of phase with respect to the index are considered countercyclical.
Indicators of Business Cycle Activity in Egypt 12

Table 3
Phase Shift with Respect to Corrected Coincident Index
and Weights and Contribution Share of the CC Coincident Index

Type Phase Shift Weights Contribution Share

RGDP Coinc 0.000 21.166 20.630
CONS Lead 0.891 6.846 0.498
GFI Lead 0.245 8.390 3.781
dNINVT Lagg -0.478 14.746 -5.875
EXP Coinc 0.056♠ -2.496 1.816
IMP Lagg -1.225♠ -0.656 0.603
SALES Coinc -0.094 12.375 11.264
SCR Lagg -0.694 -5.313♣ 8.941
RER Lead 0.458♠ -10.167 11.654
pCPI Lagg -1.656 -0.546♣ -0.003
pGDPD Lead 1.333♠ 13.974♣ 6.608
pWHP Coinc 0.064♠ 0.913♣ -0.273
M1 Lead 0.975 1.572 -0.478
M2 Lagg -0.168♠ 6.436♣ 3.996
iN3Mo Lagg -0.374 3.787 3.351
i3Mo Lagg -1.260 2.800 -0.177
iNDR Lead 1.531♠ -10.543 3.764
iDR Lagg -0.699♠ 9.573♣ 3.448
UNEMP Lead 0.894♠ 4.155♣ -0.037
GDPUS Lagg -1.517♠ 22.990♣ 26.489
♠ Countercyclical variables (in opposition of phase with respect to RGDP)

Figure 2-A sketches the resulting (corrected) coincident and the leading business cycle
indexes in growth rates- without drift- for the period 1984-2003. Visual inspection of the
diagram shows that the short period under investigation and the relatively long period of cycle
preclude the possibility of observing several complete cycles (trough to peak to trough1). In
view of that deficiency, only two truncated growth rate cycles can be visually observed for the
leading index during that period, with the first (peak to trough) beginning prior to 1984
through 1991/1992 followed by a second (trough to peak) with apparently smaller amplitude
starting thereafter with an expansion roughly in 1992/93. Looking at the diagram, two
subsequent corresponding cycles are also detected for the coincident index with the first
(trough to peak to trough) beginning in the mid 1980’s and ending in 2000 followed
presumably by initiation of a second cycle (trough). Finally, Figure 2-A reveals a time lag of
approximately nine years between the coincident index and the leading BCI.
Because visual examination is usually deceptive, the above description of the behavior
of the BCI estimates must be considered with utmost caution, merely as a means of providing
some general insights about the cyclic business activity of the economy and about the time lag
between the leading and the coincident indexes. A formal analysis of the cyclical dynamics of
the BCI estimates with precise dating of the turning points is deferred to the following
section.

1
The definition of the pattern of the cycle is followed from Burns and Mitchell (1946).
Indicators of Business Cycle Activity in Egypt 13

Figure 2
A B

Figure 2-B reports both RGDP and the coincident index in levels- after restoring the
drift- during the period under consideration. In this format, the coincident index should be
more capable of providing information about the level of economic activity in comparison
with the growth rate analogue of the index. Figure 2-B suggests that while the corrected
coincident index takes on almost the same trend as RGDP, it is marked by relatively sharper
fluctuations in comparison with both real GDP and the common component coincident index
(Figure 1-B), particularly during 1990 until 1998.
The decomposition of the common component coincident index into leading and
lagging BCIs may provide useful insights for policy analysis. The first two columns in Table
3 show which variables are coincident, leading or lagging and indicate whether they are pro-
or anti-cyclical with respect to the common component coincident index. The countercyclical
variables are denoted in the Table 3 by ♠. Starting with the components of GDP, the results
show that consumption, gross fixed investment and changes in inventories are all pro-cyclical
variables. While the first two are leading, the latter is lagging, as one would expect. The sales
variable is closely linked to GDP and, consequently, is coincident and pro-cyclical.
From Table 3, it is also observed that the variables related to the foreign sector in the
economy are generally anti-cyclical. The real exchange rate appears as a leading variable and
is countercyclical. If so, then a real depreciation of the Egyptian pound would be associated
with reduction in the growth rate of the economy. This result seems contrary to what one
normally expects. It is possible though that because of the poor competitiveness of Egyptian
exports in the world markets, exchange rate depreciation will not lead to significant rise in
exportation (Al-Shawarby, 1999). Alternatively, a real decrease in the value of the pound
could have large positive impact on the domestic prices of imports, which could lead to a
significant increase of the import bill in a way that would negatively affect economic growth.
Indeed, as Table 3 discloses, the imports variable is lagging and anti-cyclical. The findings,
therefore, cast doubt on the viability of imports as a vehicle for encouraging the growth
process in Egypt, presumably because they are mainly geared to meet the demand for final
consumption, without much regard to the needs of the production sphere.
It is discernable from its coincident nature (Table 3) that the exports indicator is more
likely to be linked with current production and output surplus rather than with planned
production targets. Furthermore, exports are anti-cyclical, which might seem a bit surprising.
One explanation is that the export sector would tend to attract the more efficient workers with
Indicators of Business Cycle Activity in Egypt 14

relatively higher wage rates. Consequently, the expansion in exportation could de facto result
in higher unemployment that would lead to lower activity and growth. This is demonstrated in
Table 3, which confirms that the unemployment indicator variable is countercyclical.
Table 3 reveals that unemployment is leading with respect to the corrected coincident
index. In the usual case, unemployment and other labor market variables are typically lagging
(Forni et al., 2000b). In Egypt, one would expect the situation to differ, as an increase in the
unemployment rate is likely to reduce the workers' earnings, which would then exert
downward pressure on consumer demand and slow down output growth. Such an argument
stresses the importance of encouraging supply-side government strategies that target job
creation and reducing the rate of unemployment as a channel for stimulating demand and
provoking economic growth.
The Suez Canal revenues indicator variable exhibits pro-cyclical tendency with a time
lag relevant to the coincident index. This implies that a rise in the overall level of economic
activity is an essential prerequisite for the development of the services sector projects, like the
Suez Canal, and for increasing their revenues.
The GDPUS indicator, included to proxy the purported influence of external forces on
the economic performance of Egypt, is anti-cyclical and lagging. On one side, relative
improvements in world conditions imply relative decline in the growth rates of the production
possibilities and of the domestic capacity. On the other side, because Egypt is a small
economy it is vulnerable to foreign shocks. To the extent that, global changes affecting the
international community are generally bound to have more rapid influence on its economy
vis-à-vis the rest of the world; hence, the lagging status of the GDPUS indicator recorded in
Table 3.
The same table demonstrates the time phase for the three inflation indicator variables.
At the beginning, while CPI inflation is pro-cyclical, both WHP and GDP price inflation are
anti-cyclical. In addition, the pCPI, pGDPD, pWHP are found to be lagging, leading and coincident
indexes, respectively.
The lagging and pro-cyclical behavior of pCPI indicates that consumer price
fluctuations are driven by demand shocks. For instance, an upward displacement of the
aggregate demand schedule, which imposes positive demand pressure on the quantity of
output growth, would eventually induce higher consumer prices. In contrast with pCPI, the
anti-cyclical dynamics of pGDPD and pWHP suggest that they are associated with aggregate
supply shocks. For instance, an upward shift of the aggregate supply schedule that leads to a
decrease in the growth rate of the quantity of production would eventually trigger a rise in
both WHP and GDP price inflation. While the coincident character of WHP inflation
emphasizes the contemporaneous relationship between producer prices and output growth, the
pGDPD lead manifests the effect of variation in the GDP deflator on producers’ expectations
about the credibility of the economic environment and on their production decisions.
The above findings have several implications that may be of interest for the Egyptian
policy makers. Importantly, consumer price inflation is a monetary phenomenon. CPI
inflation shocks are transient impulses that are mainly induced by monetary innovations
whereas changes in pGDPD and in pWHP are more persistent and might be associated with
permanent changes in the economic growth rate, since they are primarily related to real
perturbations in the economy. Hence, supply-side policies that seek innovative improvements
in the quality of the factors of production and higher levels of employment for labor and for
other inputs could help in expanding output growth and reducing GDP deflator and WHP
inflation.
Indicators of Business Cycle Activity in Egypt 15

In keeping with this analysis, it is deduced that the burden of restraining CPI inflation
should primarily fall on the Central Bank. Alternatively, dealing with pGDPD and pWHP
fluctuations certainly could not be left exclusively to the discretion of the monetary authority.
Along with Central Bank, various institutions in the real sector of the economy (including
producer guilds and associations, research institutes and labor syndicates) should be
encouraged to take on an active role in stabilizing price (WHP and GDPD) variations through
encouraging technical progress and productive efficiency of the firms and of the factors of
production in the economy
Turning to the analysis of the behavior of the six monetary indicator variables
included in the dataset, Table 3 shows that they are interest rates (nominal and real), discount
rates (nominal and real) and the aggregate money balances, M1 and M2.
Both nominal and real interest rates (iN3Mo and i3Mo, respectively) are lagging and pro-
cyclical. This result denotes that, during the period under examination, the interest rate might
have been used as an instrument for implementing anti-cyclical policy. Conversely, the real
discount rate (iDR) is lagging and anti-cyclical, implying that it has been used as a tool to
implement pro-cyclical policy. Like iDR, the nominal discount rate (iNDR) is in phase delay
with respect to the coincident index; however, it is a leading indicator variable. This result is
taken to underscore the endeavors of the monetary authority to utilize the nominal discount
rate as an ex-ante policy instrument aimed at raising investment and economic activity.
With regard to money balances, it is found that M1 is pro-cyclical and leading, thereby
suggesting that the Central Bank has used this variable as a real expansionary policy
instrument. Apparently, the fact that M2 incorporates less liquid assets and possibly a sizable
amount of savings deposits owned by households living on the interest payments generated by
these deposits precludes the potentials for using this variable as a real pro-cyclical monetary
policy instrument. While these findings suggest disparity in the behavior of M1 and M2, this
result must be considered with prudence.
Up until now, the study has been concerned with learning whether the indicator
variables are pro- or anti-cyclical with respect to the coincident index. Equivalently, it is
possible to examine the cyclical relation between the selected indicators and the common
component coincident index, ∆CCI. As it turns out, such examination allows for retrieving
additional information from the GDFM estimates that could explain and trace the different
driving forces of the growth rate cycle in Egypt through identifying the contribution of each
of the variables that have been used to construct the index (Inklaar et al., 2004).
Table 3 reports six variables with negative weights. The negative sign indicates that
these variables are countercyclical with respect to ∆CCI and inversely correlated with real
GDP. It is discernable from the table that there are eight variables (SCR, the inflation
variables pCPI, pGDPD and pWHP, M2, iDR, UNEMP and GDPUS), which exhibit a cyclical
relationship with respect to ∆CCI that is opposite to the estimated cyclical relationship
between those variables and the corrected coincident index. The divergence between the
results from the corrected and common component coincident indexes should not be
considered as evidence of an error, but rather largely as a sign marking the importance of
considering the effect of lags and leads on the cyclical behavioral pattern of output growth.
For example, El Mossallamy (2004) emphasizes the unstable nature of the Phillips
curve in Egypt and implicitly suggests that rising unemployment has been frequently
associated with an increase in output, especially during the last decade or two. The pro-
cyclical relation between unemployment and ∆CCI provides corroborating evidence for the
breakdown of the Phillips' relation. The failure to model the leads and lags underlying output
Indicators of Business Cycle Activity in Egypt 16

fluctuations dynamics, however, might be the main reason for this positive correlation. Once
these dynamics are controlled for, the countercyclical relation between production and
unemployment is uncovered, and it may be possible to salvage the usual Phillips relation. The
phase shift of UNEMP with respect to the corrected index, reported in Table 3 provides
support for this argument.
The relationship between ∆CCI and the inflation indicators contradicts prior
expectations. CPI inflation is anti-cyclical, suggesting that it is driven by aggregate supply
perturbations. Although Moursi (1998) records situations when variances in consumer prices
were countercyclical for short durations due to transient aggregate supply and aggregate
demand adjustments, this situation is not likely to persist for an extended period. Obviously,
the corrected index is able to fix this problem by dichotomizing the dynamical leading and
lagging behavior of consumer price fluctuations. An analogous line of reasoning holds for the
GDP deflator and the WHP inflation indicator variables.
Besides GDPUS, the weights depicted in Table 3 suggest that GDP is the most
important indicator variable with a weight of 21.2 percent. The result is quite interesting as it
emphasizes the important influence of external factors and shocks on the cyclical dynamics of
output growth in Egypt (Kheir El Din and Moursi, forthcoming). But those two indicators are
not the only variables with significant weight. For instance, dNINVT, GDP inflation, SALES,
iNDR and RER possess relatively large weights ranging between 14.8-10.2 percent.
The final column in Table 3 reports the contribution shares for the twenty indicators.
Again, next to GDPUS, real GDP has the highest share (20.6 percent). Six variables,
especially changes in inventories (dNINVT) make negative contributions to the index mainly
because of their large contribution shares in years when the index is relatively low. The table
also reveals that the magnitudes of the contribution share of GDP and its weight are extremely
close. Such a relation does not hold for several other indicators including GDPUS, real and
nominal discount rates, consumption, change in inventories and GDP deflator inflation whose
contribution shares diverge from relevant weights. This divergence cannot be attributed to
relative size of changes in the indicators because all variables are normalized. The difference,
however, suggests that the movement of the indicators with larger divergence between
contribution share and weight is relatively less synchronized with the movement of the
common component index in contrast with the other indicators (Inklaar et al., 2004).
It is interesting to note that there are several key variables, like unemployment,
imports and WHP inflation, which make a small contribution to the index. While it can be
argued that the reported unemployment rates might underestimate the actual rate, the small
contribution of the two other variables to the index warrants further investigation. Actually,
on purely statistical grounds, confirming the small magnitude of these indicators could
eventually suggest removing them from the calculations as a means of improving the index
estimates through reducing idiosyncratic noise in the system.
Finally, before concluding this section, it may be worthwhile to get an idea about the
efficiency of the BCI estimates. Figure 3 portrays the spectral density of the coincident index
and of the idiosyncratic component of RGDP. The spectral shape of the coincident index
suggests that most of the variance of the indicator is instigated by cycles of at least two and
one half years with a maximum attained at frequency zero. The diagram also reveals that the
spectral density of the idiosyncratic component is significantly flat and that it accounts for just
about 8 percent of total variance in RGDP. The shape of idiosyncratic component provides
support for the maintained assumption that it is a white noise process, which may be
attributed mainly to measurement errors, and, therefore, may be virtually ignored in the
estimation of the coincident index.
Indicators of Business Cycle Activity in Egypt 17

Figure 3

Additionally, Figure 4 plots the coincident index in level without drift along with the
one-step-ahead forecast for the period 1994-2003. Inspection of these forecasts substantiates
the viability of the estimates and of the underlying model.

Figure 4
Indicators of Business Cycle Activity in Egypt 18

4. Turning Points Dating for BCI Estimates

BCIs are importantly of use in identifying the cyclical turning points (peaks and
troughs) of the classical and of the deviation cycles, i.e. of the level and of the growth rate of
GDP, respectively. As mentioned above, the BB (1971) algorithm is selected for formally
dating the turning points of both classical and growth cycles, the appropriateness of this
selection notwithstanding.

Figure 5-A
Real GDP: Growth

As usual, the classical cycle is capable of explaining absolute upturns and downturns
in economic activity while the growth cycle reveals the expansions and contractions in the
rate of growth. The classical cycle is described by annual real GDP and by the common
component coincident BCI of Egypt (after cumulatively restoring a deterministic trend). Both
series are portrayed in Figure 1-B. The growth cycle is defined in terms of real Egyptian GDP
growth and the common component and the corrected coincident indexes depicted in
Figures 5-A and Panels I and II of Figure 5-B. In addition, cyclical fluctuations are identified
by the same two coincident indexes in levels prior to restoration of the trend. In all these
diagrams, the specific peaks and troughs, which are estimated according to the BB procedure,
are labeled. Furthermore, the shading in the diagrams signifies the periods between the peaks
and troughs. Consequently, the shaded area indicates recessionary periods in those figures that
represent the classical cycles and periods of diminishing economic growth in those figures
that represent the growth cycles. In order to facilitate the diagrammatic exposition, Table 4
summarizes these results for GDP, for the common component and the corrected coincident
indexes and for the leading BCI as well both in levels (upper Panel) and in growth rates
(lower Panel).
Table 4 shows that the BB algorithm cannot spot the classical cyclical turning points
in either the RGDP series or the common component coincident index level with the trend
restored (Figure 1-B). Aside from believing that there might have not actually been any
encounters of absolute expansions and contractions in activity level during 1984-2003, it is
possible that the period in question is indeed too short to signal the presence of turning points,
especially in view of the tendency of the BB algorithm to smooth peaks and dips (Inklaar et.
al., 2004).
Indicators of Business Cycle Activity in Egypt 19

Table 4
Business Cycle Turning Points

CC
RGDP Coincident Leading
Coincident
Level
♣
Peak … 1990 1995♣ …♣
Trough … 1996♣ 1987,2000♣ 1992♣
Growth
Peak 1998 1998 1991 1993
Trough 2002 2002 1998 1989
♣ With no trend restored.

In contrast, Figure 5-A reveals two turning points of the RGDP growth rate cycle
corresponding to a peak and a trough in 1998 and 2002, respectively. The growth cycle
common component coincident index (Figure 5-B, Panel I) is completely successful in
matching the two cyclical turning points of RGDP growth, thus providing evidence to buttress
the efficiency of the estimated index in capturing the dynamical growth of GDP in Egypt
during the selected period.

Figure 5-B
Business Cycle Index: Growth
I II

According to Kheir El Din and Moursi (forthcoming), Egypt witnessed relatively

significant progress in economic performance in 19911. The improvements appeared to hinge
on two factors: the rise in the domestic supply of typically scarce foreign currency due to
external debt forgiveness in return for Egypt’s political role in the Gulf war and the
implementation of ERSAP, which raised technical progress and the contribution of total
factor productivity (TFP) to GDP growth. They attribute the bigger role of TFP in output
growth to the sharp dec1ine in the contribution of physical capital arising from a fall in
investment. Moreover, the decrease in investment led to an unprecedented fall in the
contribution of physical capital to growth after 1991, which must have curtailed the
1
Kheir El Din and Moursi’s study covers the period from 1960 until 1998.
Indicators of Business Cycle Activity in Egypt 20

economy’s capacity to sustain the 1991 rise in economic growth. However, the deviation
cycles associated with the common component coincident index and GDP growth (Figures 5-
B-I and 5-A, correspondingly) seem unable to embody these changes.
The corrected coincident index, depicted in Figure 5-B-II, clearly shows Kheir El Din
and Moursi’s purported cyclical peak of 1991. The coincident index also portrays the
slowdown in economic growth that occurred in the aftermath of the initiation of ERSAP,
which eventually ended with a cyclical growth trough in 1998 (Table 4 and Figure 5-B-II).
The rise in growth rate after 1998, however, is not enough to lead to a peak before the end of
the period under consideration.
It is perceivable that the strong visible trend (Figure 1-B), which dominates the
historical evolution of the level of real GDP is responsible for suppressing the turning points
of the RGDP series. To be sure, the common component and the corrected coincident indexes
in levels without restoring the deterministic trend are estimated. The two indexes are sketched
in Figure 5-C, Panels I and II. As it appears from the diagrams, in contrast with the CC index
plus trend (Figure 1-B), the common component and the corrected coincident indexes in
levels with no trend are characterized by cyclical turning points. Actually, according to the
BB algorithm, while the common component index shows a peak and a trough in 1990 and
1996, respectively, the coincident index indicates the occurrence of a trough followed by a
peak and another trough in 1987, 1995 and 2000, correspondingly. These results are
documented in Table 4.

Figure 5-C
Business Cycle Index: Level (with No Trend Restored)
I II

Figure 5-C demonstrates some basic disparities between the common component and
the corrected indexes in levels without a trend. The differences relate to the datings of the
turning points and to the behavioral pattern of the indexes themselves. For example, the
common component index (Figure 5-C-I) is not successful in capturing the (quasi-) absolute
improvement in economic activity during 2000-2003, which is discernable from the corrected
index drawn in Figure 5-C-II1. More important, a comparison between these two figures
shows that the corrected index indicates that the economy has been subjected to fairly

1
Although the index is expressed in levels, the trend has not been restored. In that sense, the index would
represent only quasi-absolute rather than absolute change in the level of economic performance.
Indicators of Business Cycle Activity in Egypt 21

extensive recessionary spells, at least in comparison with those implied by the CC index
during 1984-2003.
Although the level and growth variants of the corrected BCIs are designed to represent
different cyclical phenomena, they are not completely unrelated. In order to help in
understanding possible interaction between these indexes, the BB algorithm is called upon
once more for dating the turning points of the leading BCI. The cyclical peaks and troughs for
the level (without trend) and the growth rates versions of the leading index are presented in
Table 4.
Despite the short period under examination, these findings reveal that the leading
index is generally capable of forecasting the turning points of the coincident index. Table 4
illustrates that the quasi-classical coincident index trough of 2000 is preceded by that of the
leading BCI in 1992. Alternatively, the growth rate dip of the leading index in 1989 occurs
well before the trough of the coincident index growth cycle in 1998.
The lengthy lag (eight to nine years) between the leading and the coincident index
troughs is somewhat surprising. It may be difficult to determine the exact reason for this long
lag. However, if there is a problem, it is not related to the implementation of the BB
algorithm because an analogously long lag exists when the algorithm is used in dating the
tuning points of the (quasi-) classical cycle. Instead, it is more likely that the short period
under study and the low (annual) frequency of the estimated indexes preclude comprehensive
recognition of all the cyclical turning points that may actually exist.
Leading information about economic activity need not only be derived from the
leading index. The literature suggests that the interaction between the classical cycle and the
growth cycle coincident indexes can provide pertinent leading insights about the economy's
performance. Inklaar et al. (2004) draw attention to the fact that the turning points of the
growth rate cycle typically lead to turning points of the classical cycle because the growth
usually decreases before growth becomes negative.
Along that line, the results displayed in Table 4 show that the growth rate cycle peak
(trough) of 1991 (1998) have caused a corresponding peak (trough) of the quasi-classical
cycle (with no trend) in 1995 (2000), with a gap of four (two) years between the turning
points. It is of interest also to see that the trough of leading index in level of 1992 is probably
the result of the 1989 downturn of economic growth depicted by the growth rate cycle of the
same index. In this case, the gap between the two troughs is three years. Moreover, it is
noticed that the time delay between leading information and corresponding changes in the
classical cycle is shorter (approximately 50 percent) in comparison with the leading time gap
between corresponding turning points of the leading and the corrected coincident indicators in
level and in growth rate. According to this discussion, therefore, it becomes clear that growth
rate cycle can provide the decision maker with important leading information about
anticipated changes in the level of economic activity.
Indicators of Business Cycle Activity in Egypt 22

5. Conclusion

The liberalization of the Egyptian economy, initiated in the seventies, raised

suspicions among a host of public policy makers, of businesspersons and of academicians,
that economic activity has been characterized by intermittent phases of expansions and
recessions. So far, however, cursory examination of real GDP, of its growth and/or of other
important macroeconomic indicators has not been able to unequivocally confirm or refute
these suspicions. In this study, a set of BCIs are formally estimated, which shed light on the
cyclical dynamics of economic activity in Egypt during the period 1984-2003. To the best of
one's knowledge, BCIs of real economic activity have not been previously estimated for the
Egyptian economy. In general, the findings of this research confirm the suspicions that the
real activity in the economy, as well as the economic growth rate, has been characterized by
periods of upturns followed by contractions, at least during the period under consideration.
The main goal in this paper has been to uncover the cyclical behavior of the economy
and the comovements of selected macroeconomic indicators through the estimation of real
BCIs for Egypt. To meet this goal, the GDFM, introduced in two seminal papers by Forni et
al. (2000a and 2000b), has been applied to estimate the common component coincident index
for real economic activity in Egypt during the period 1984-2003 using annual data on twenty
key macroeconomic indicators. The BCIs are estimated corresponding to the growth cycle and
to the classical cycle of real GDP in growth rate and in level, respectively. Furthermore, the
common component coincident index is used to compute corrected coincident and leading
indexes. A phase analysis is utilized in order to determine the time lead of each variable with
respect to the common component coincident index. The analysis also classifies the indicator
variables as either pro-cyclical or anti-cyclical with respect to the common component index.
Finally, the BB algorithm is used for dating the cyclical turning points of the different BCIs.
The findings of the study reveal that the Egyptian economy has indeed been subjected
to real cyclical fluctuations between 1984-2003. The results show that real GDP has the
highest commonality with other indicator variables; hence, the estimated common component
of GDP could be considered as an appropriate measure of business cycle fluctuations.
Moreover, the classification of the indicator variables into countercyclical and pro-cyclical
and the identification of turning points have been quite useful in explaining the real dynamic
behavior of the selected macroeconomic variables and of the whole economy and in
understanding the performance of leading indexes as a tool in policy analysis. Of course, the
proposed policy implications of the analysis are not fully considered and need to be
scrutinized much more closely in the future.
In general, this paper serves two purposes. First, it empirically demonstrates to
Egyptian researchers in a straightforward way how to estimate coincident and leading BCIs of
real economic activity, how to evaluate their performance and how they may be useful for
policy oriented analysis. Second, it provides some formal evidence about the comovement of
important macroeconomic variables and identifies specific periods of real expansions and
contractions in the growth rate and in the overall level of activity.
Two potential problems need to be addressed in the future. Both relate to the data,
which are employed in the estimation of the indexes. Getting the right indicator variables for
computing the BCIs cannot be overemphasized. It is definitely a challenge to assemble the
right data that are required for investigating the cyclical behavior of real economic activity in
Egypt. Along these lines, the following two problems are discussed.
Indicators of Business Cycle Activity in Egypt 23

First, it has been pointed out that the time gap between the leading and the coincident
indexes is rather long (roughly eight years). It likely that this relatively long lead arises
because of the utilization of low frequency annual data in the computation of the indexes and
because the period over which the indexes are calculated is too short (twenty years).
Accordingly, it is extremely important to articulate a suitable high frequency dataset that
chronologically covers an extended period of Egypt's recent history. Second, it seems
necessary to employ a limited number of variables in the construction of the BCIs. It is
important to collect both high and low frequency information on a bigger set of indicator
variables in order to improve the efficiency of the estimated business cycle indexes. Since the
availability of these data from international sources is limited, the only remaining alternative
would be to resort to national institutions in order to articulate such information. This is
indeed a formidable challenge.
Indicators of Business Cycle Activity in Egypt 24

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