Introduction of chain-linking into national accounts by JasonDetriou


									               Introduction of chain-linking into national accounts

1.     What is new?

In 2005 and 2006, most Member States of the European Union will introduce chain-linking in
their quarterly and annual national accounts to measure the development of economic
aggregates in volume terms. A few Member States have already implemented this method.
Chain-linking is also used in the US, Canada, Australia and Japan. End of November 2005,
Eurostat will make the changeover to chained volume measures for quarterly and annual
European aggregates.

Chain-linking will improve the accuracy of estimates of economic growth. Moreover, its
introduction in the EU will lead to improved international comparability of data.

2.     What is the reason for the methodological change?

Changes over time in the value of economic aggregates can be factored into two components
reflecting (i) changes in the prices of goods and services and (ii) changes in their volumes. In
order to measure volume growth of GDP and its components, the effect of price changes has
to be eliminated (i.e. prices have to be kept constant). In the past, this has been done by
choosing one year (the so-called base year) and then aggregating volume changes in
subsequent periods using the price structures and weights of this fixed base year. Thus, the
value of the aggregates in subsequent periods were said to be expressed in „constant prices of
the base year‟.

But, over time, the relative prices in the base year tend to become progressively less relevant.
This impacts in particular on the estimates of growth for periods which are distant from the
base year. Hence, from time to time, it is necessary to choose a more recent base year. It has
been current practice to update base years about every five years.

In times of high dynamics of relative prices and the associated volumes, however, updating
base years every five years or even at longer intervals is not sufficient to reflect the changing
economic environment. In the recent past it was mainly the growing importance of
information, communication and technology (ICT) goods that has demonstrated how dramatic
changes in price structures can be. But with the increasing globalisation of markets and high
competitive pressure it is likely that high price dynamics and rapidly changing price structures
will be lasting features of modern economies.

3.     What is chain-linking?

The basic idea of chain-linking is to update the base year at a higher frequency and link the
short-term movements. In Europe and in many countries outside Europe updating will be
done on an annual basis.
In that case, period to period changes of volumes (the links in the chain) are calculated using
the prices (and hence weights) of the previous year. That way the use of up-to-date price
structures is ensured.
Take, for example, household consumption expenditure. The growth in volume terms between
years 1 and 2 is calculated by comparing consumption of year 2 expressed in prices of year 1
with consumption of year 1. Growth between years 2 and 3 is calculated by comparing
consumption in year 3 expressed in the prices of year 2 with consumption in year 2, and so

The changes between consecutive periods are then linked together (“cumulated”) to form
chained volume measures that show changes in a time series perspective.

Chain-linking of annual data

Annual chain-linking follows exactly the principle described above. In Europe, the year-on-
year volume changes are calculated using the Laspeyres index formula to aggregate volume
measures at the elementary level. After linking the year-on-year changes the result can be
described as annually reweighted chain Laspeyres volume measures. In other words, GDP
volume growth in a certain year is calculated as weighted average of the volume growth of the
GDP components, using the current price value shares of the previous year as weights for the

Chain-linking of quarterly data

Chain-linking of quarterly data is technically more complicated 1. There are three well-known
techniques for linking the quarterly elements of the chain: one-quarter overlap, annual overlap
and over-the year (for details see the references given in section 10). 2 Quarterly European
aggregates will be calculated on the basis of Member States‟ data in previous year‟s prices.

4.       Legal framework

Chain-linking of volume measures in annual national accounts is stipulated in Commission
Decision 98/715 (see reference in section 10).

There is no legal requirement for chain-linking of quarterly data. For reasons of consistency,
however, there is a strong case for applying chain-linking to quarterly data, as well. Most
Member States will have introduced quarterly chaining by 2006.

  Chain-linking of quarterly data can be done on a quarterly basis or annually. In the former case quarter-on
quarter growth rates are linked. This approach, however, faces the risk of the so-called drift problem (see
SNA93, chapter XVI for details). EU Member States and most other countries have decided instead to chain-link
quarterly data annually, i.e. to chain-link quarterly estimates compiled at the average prices of the previous year.
  The choice of linking technique, while known to potentially produce different results, has proven to usually
have only minor impact on the results when applied to actual national accounts data.
5.     Changeover timetable for Member States

Table 1 provides an overview of Member States‟ plans for the first-time provision of chain-
linked data.

                      Table 1: Availability of chain-linked volume data
                                Current planning – status March 2005
                                    Annual National Accounts         Quarterly National Accounts
                Belgium                  September 2006                    December 2006
            Czech Republic                                Already providing
               Denmark                                        July 2005
               Germany                       May 2005                         May 2005
                Estonia                         n.a.                              n.a.
                 Greece                                   Already providing
                  Spain                                       May 2005
                 France                  Already providing                    May 2006
                 Ireland                   End Q2 2005                            n.a.
                   Italy                 September 2005                    December 2005
                 Cyprus                                   September 2005
                  Latvia                                        2007
               Lithuania                 September 2005                       June 2005
             Luxembourg                  Already providing                    April 2005
                Hungary                                         2006
                  Malta                                   Already providing
             Netherlands                                  Already providing
                 Austria                                  Already providing
                 Poland                                   Already providing
                Portugal                                  Already providing
                Slovenia                                        2006
                Slovakia                 December 2005                        March 2006
                Finland                  December 2005                      February 2006
                Sweden                                    Already providing
            United Kingdom                                Already providing
          The dates given are indications. Dates are ultimately fixed by National Statistical Institutes.

6.     European aggregates

Chain-linking will also be applied to the European aggregates. Chained volume measures will
be estimated from Member States‟ data expressed in the prices of the previous year. As
linking technique for quarterly data Eurostat uses the one-quarter overlap with a
benchmarking to annual data.
Eurostat plans to introduce chain-linking to both annual and quarterly European
aggregates starting with the first regular release for the 3rd quarter 2005, i.e. on 30
November 2005.3

7.      Presentation of data

On its website Eurostat will present volume measures in three forms
-      growth rates
-      (chain) index (year 2000 = 100)
-      chained level series

Growth rates: For annual series year-on-year growth rates will be shown. For quarterly
series, the growth rate compared to the previous quarter as well as the growth rate compared
to the same quarter of the previous year will be given.

Index: Chained volume measure series will be expressed as index numbers in which the
series is scaled to a value of 100 in one year, which is called the reference year. Eurostat will
use the year 2000 as reference year for the chain indices. The choice of the reference year has
no impact on the movements in the series.

Chained level series: Chained volume measure series will also be shown and referenced onto
the year 2000. These level series are obtained by multiplying the chain index by the current
price figures in the reference year 2000.

8.      What users should also know

Users who want to work with the chained level series must be aware that chain-linking results
in the loss of additivity of volume data (except for the data relating to the reference year and
the one following the reference year). The loss of additivity means, for example, that in the
chained level series the components of GDP do not add up to GDP (except for the reference
year and the year following). In general terms: the chained level of an aggregate is not equal
to the sum of the chained components. Non-additivity is also relevant for geographical
aggregations (euro zone and EU25). Non-additivity arises for purely mathematical reasons;
the discrepancies cannot and should not be interpreted as indications of quality.

9.      Expected effects

For recent years, the change-over to chain-linking is expected to reduce volume growth
slightly for GDP and most components. This is because fast growing product groups tend to
be those for which prices increase less than average or decline (as it is observed for products
of information and communication technology). Hence, when GDP volume growth is
calculated using more recent weights, the product groups with strong output growth get a
lower weight, resulting in a lower GDP volume growth.

  At the same time, the allocation of FISIM will be introduced in national accounts. This methodological change
is outlined in a parallel document.
Test results from Member States point to differences of maximum 0.2 percentage points for
annual GDP growth rates compared to a system with a fixed base year. The effect for GDP
components may, however, be larger, albeit cancelling out to a large extent at aggregate level.

10.    References

Further details on chain-linking and volume measures can be found in the following

-      98/715/EC: Commission Decision of 30 November 1998 clarifying Annex a to
       Council Regulation (EC) No 2223/96 on the European system of national and regional
       accounts in the Community as concerns the principles for measuring prices and

-      Eurostat - Handbook on Price and Volume Measures

-      International Monetary Fund - Quarterly National Accounts Manual – chapter IX

-      System of National Accounts 1993 (SNA 93) - chapter XVI

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