Page 154 - Contributed Paper Session (CPS) - Volume 8

CPS2223 Siti Nuraini R. et al.
4) Real Imports of 4) Real Contribution, 3) Exports of Natural
Other Basic EPF Gas & Crude Oil
Precious & Other 5) Capacity Utilisation, 4) CPI for Services
Non-ferrous Metal Manufacturing
5) Number of Housing 6) Volume Index of
Units Approved Retail Trade
6) Expected Sales
Value,
Manufacturing
7) Number of New
Companies
Registered
Another important source of information that can be used to confirm the
business cycle is diffusion indexes. According to Meşter (2007), diffusion
indexes are not redundant even though they are based on the same set of
data as the composite indexes. Diffusion indexes used to measure how
widespread a particular business movement (expansion or contraction) has
become and measure the width of that movement. Meanwhile, the composite
indexes, differentiates between small and large overall movements in the
component’s series. Occasionally, these two indexes move in different
directions and the dissimilarity can be used to confirm or anticipate cyclical
turning points.
The objective of this paper is to examine the accuracy of time series
forecasts of recessions for the Malaysian economy, using composite and
diffusion of LI for the past recession period from January 1991 to October 2018
using the “Three Ds” approach.

2. Methodology
Identifying the turning points is not an easy task even for the expert
analysts. In practice, the economist and analysts apply rules of thumb to help
identify recent turning points and coming recession (Meşter, 2007). One of
them is using the “Three D’s” – the duration, depth and diffusion method.
Based on the “Three Ds” approach, the longer the weakness continues, the
deeper it becomes; and the more widespread it turns out to be, the more likely
recession will occur. According to this approach, a recession usually follow
when the (annualized) six-months decline in the LI reaches 4.0-4.5 per cent
and the six month diffusion index falls below 50.0 per cent (The Conference
Board, February 2010).
The LI does not increase or decrease in long continuous movements.
Expansions are spread with a few months of decline, and recessions include
months of increase. Interpreting declines in the LI using duration eases the
emergence of short-term patterns or trends. Meanwhile, the depth and

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