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CPS2223 Siti Nuraini R. et al.
diffusion of those declines help to define how likely a short-term fluctuation
is to be a recession warning. This motivates the use of the Three D’s in
conjunction with one another.
The duration interval of a decline is perhaps the most obvious signal of
imbalances in the economy, which might eventually enter a recession as a
result. However, for reliable interpretation of these declines, most economists
also require a significant downward movement in the index, as well as declines
in the majority of the component series. These are the second and third
aspects of the Three D’s - depth and diffusion. In brief, the greater the decline
(depth), the more likely it is that a serious economic downturn will occur and
the more likely that the decline is not a random fluctuation. The seriousness
of the decline can be assessed by calculating the per cent change of the
decline over a given span of months.
Source of data for this study is composite and diffusion of LI for the period
of January 1991 to October 2018 which was taken from Malaysian Economic
Indicator: Leading, Coincident & Lagging Indexes.

3. Result
Chart 2 shows the annualized six-month changes and the durations in
which the diffusion index falls below 50 per cent. Numbers next to the grey
shaded region denote the lead times of each of the past peak for three
recessions since 1991. The average lead is five months.
Looking at data month on month, it is clear that the LI has many brief
declines that have nothing to do with cyclical downturn in the economy. For
example, in April 2002 reading for LI is 3.0 per cent and declined to -2.8 in
December 2002. It started to rebound in January 2003 which indicating LI gave
a false alarm of recession for this period.
Generally, a recession started when two criteria of “Three D’s” approach
are met simultaneously across a six-month period. Based on this study, the cut
of point of annualized changes to ensure that it is recession is below -2.6 per
cent for data series January 1991 to October 2018 and the diffusion index is
below 50 per cent.
As of April 1998, the annualized changes rate is -5.9 per cent which is
below -2.6 per cent, and the diffusion index was below 50.0 per cent.
Concurrently, the annualized changes rate in December 2008 is -4.6 per cent
and the diffusion index was below 50.0 per cent. Hence, LI was managed to
give an early signal of the real recession for both periods. Recently, the six-
month growth rate of LI in May 2018 reached -2.6 per cent. However, the
growth rate starts to pick-up again. So, it is a false signal of recession.

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