Enhanced Step-By-Step Approach for the Use of Big Data in Modelling for Official Statistics

Enhanced step-by-step approach for the use of big data in modelling for official statistics

Dario Buono1, George Kapetanios2, Massimiliano Marcellino3, Gian Luigi Mazzi4, Fotis Papailias5

Paper prepared for the 16th Conference of IAOS OECD Headquarters, Paris, France, 19-21 September 2018

Session 1.A., Day 1, 19/09, 11:00: Use of Big Data for compiling statistics

1 Eurostat, European Commission. Email: [email protected] 2 King’s College London. Email: [email protected] 3 Bocconi University. Email: [email protected] 4 GOPA. Email: [email protected] 5 King’s College London. Email: [email protected]

Dario Buono [email protected], European Commission

George Kapetanios [email protected] King’s College London

Massimiliano Marcellino [email protected] Bocconi University

Gian Luigi Mazzi [email protected] GOPA

Fotis Papailias [email protected] King’s College London

Enhanced step-by-step approach for the use of big data in modelling for official statistics

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Prepared for the 16th Conference of the International Association of Official Statisticians (IAOS) OECD Headquarters, Paris, France, 19-21 September 2018

Note (optional): This Working Paper should not be reported as representing the views of the Author organisation/s. The views expressed are those of the author(s).

ABSTRACT

In this paper we describe a step-by-step approach for the use of big data in nowcasting exercises and, possibly, in the construction of high frequency and new indicators. We also provide a set of recommendations associated to each step which are based on the outcome of the other tasks of the project as well as on the outcome of the previous project on big data and macroeconomic nowcasting. Specifically, we consider issues related to data sources, access, preparation, cleaning/filtering, modelling, and evaluation.

Keywords: Big Data, Macroeconomic Nowcasting, Econometric Models, construction of new indicators; Outliers; Seasonality; Unstructured data.

1 INTRODUCTION

Recent advances in IT and the social use of Internet related applications make nowadays a vast amount of information available in real time. The associated Big Data are potentially very useful for a variety of applications, ranging from marketing to tackling tax evasion. From the point of view of statistical institutes, the main question is whether and to what extent Big Data are valuable to expand, check and improve the data production process. In this paper we focus on three particular cases of using Big Data in official statistics. The first one is macroeconomic nowcasting, thus potentially enhancing the timely availability and precision of early estimates of key macroeconomic variables, and possibly providing new Big Data based coincident and leading indicators of economic activity. The second is represented by the possibility of using big data in the construction of new high frequency versions of already existing macroeconomic indicators. This could, for example, concern the estimation of daily or weekly proxies of GDP or of inflation. An example can be found in Aprigliano et al. (2016). The last one concerns the possibility of using big data to construct new qualitative or quantitative indicators measuring phenomena for which official statistics had problems to find appropriate information to satisfactorily measuring or describing them. This could be the case of pressure indicators (like for prices or for consumers) and of wellbeing ones. While clearly potentially of important value in the contexts mentioned above, Big Data still raises a number of old and new issues, related to data availability and accessibility, data preparation, cleaning and filtering, data modelling, validation and evaluation. All these aspects have a great relevance in the context of official statistics. Furthermore, the use of Big Data also requires proper statistical and econometric modelling as well as evaluation techniques. A wide range of methods are available, but they should be used in a careful way as they have been developed either (in the econometric literature) to handle large but not really big datasets of time series, or (in the statistical and machine learning literatures) to model really big datasets of iid observations, while we would like to work with big sets of correlated time series. Broadly speaking, the available methods are based either on summarizing the many variables, or on selecting them, or on combining many small models, after a proper data pre-treatment. Obviously the above considerations apply to the case of numerical big data previously converted into a set of time-series. This approach is especially relevant for nowcasting exercises or even to construct high frequency indicators. Nevertheless when constructing new indicators, especially qualitative ones, it is possible that non-numerical big data (such as textual or image ones) have to be considered. In such situation, since the conversion into time series or even panel data is not feasible, we are obliged to work in unstructured data and the problems are even more difficult to solve. In this case, we need to base our process of construction on typically multivariate tools of data exploration such as data mining or data analytics (or their extensions such as text mining). The characteristics of these methods call for an even higher carefulness in considering the outcome of such investigations. Given this complex background, in this document we develop a step-by-step approach, accompanied by specific recommendations for the use of big data for macroeconomic

nowcasting, construction of high frequency indicators and of new indicators. The approach proposed here in- tends to generalise and extend the one already proposed by Mazzi (2016) and Kapetanios et al. (2017). Besides the generalisation to different kind of usages of big data, the extensions proposed here mainly concern:

• the analysis of the usefulness of various types of big data when constructing different indicators,

• the methods for converting unstructured numerical big data into time series structured ones,

• the seasonal and calendar adjustment,

• the identification of advantages and drawbacks of statistical methods to be used when dealing with non-numerical big data.

Keeping unchanged the philosophy used in the previous papers, the step-by-step approach proposed below is intended to guide researchers and statisticians from the identification and the choice of Big Data to its pre-treatment and econometric/statistical modelling until the construction of indicators and the comparative evaluation of results. With this step-by-step approach we aim to provide researchers and statisticians with a very useful, flexible and complete tool for decision making about: if, when, how and for what using big data in official statistics. More specifically:

• Step 1 considers the clear specification of the statistical problem (i.e. nowcasting versus high frequency indicator versus new indicator);

• Step 2 refers to the definition of an appropriate IT environment for collecting, storing, treating and analyzing big data;

• Step 3 considers Big Data potential usefulness within the statistical exercises as defined in step 1;

• Step 4 discusses issues related to the design of the exercise: possible big data sources, definition of the type of variables/information to be extracted from big-data, etc.;

• Step 5 assesses big-data accessibility and the quality of envisaged big-data sources;

• Step 6 focuses on big data specific features and on possible ways to move from unstructured to structured data;

• Step 7 deals with the approaches to replace missing observations as well as to remove and correct outliers; • Step 8 deals with the ways for filtering out seasonal and other very short-term components from big data;

• Step 9 concerns the presence of bias in big data and the ways to correct it;

• Step 10 analyzes the design of the econometric modelling strategy in case of the availability of numerical big data structured in time series form;

• Step 11 considers the statistical exploratory techniques to be used in case of non- numerical or numerical but not structured big data;

• Step 12 deals with the evaluation of the results mainly obtained in steps 10 and 11 (choice of benchmark model or nowcasts, evaluation metrics, criteria for assessing the significance of the accuracy and/or timeliness gains, the statistical and economic validity of the results, etc.);

• Step 13 considers the overall implementation of big data based results within the regular production and dissemination process;

All these steps are discussed in the various subsections of Section 2. Each subsection is structured into two parts: the first one providing a description of the problem and related issues and the second one providing specific recommendations. Section 3 proposes a more compact presentation of the step-by-step approach and briefly concludes.

2 A STEP-BY-STEP APPROACH

In this section the 13 steps listed above are presented in details, focusing on the main theoretical and empirical aspects characterizing each step and deriving recommendations reflecting the experience of the authors in dealing with big data as well as some relevant literature contributions in this field.

2.1 Step 1: Identification of the Statistical Problem 2.1.1 Description

Before starting the search phase for identifying possibly useful big data, it is important to clarify in the most accurate way the problem we want to address. In particular, in case of a nowcasting exercise, it is important to specify the expected gain in terms of timeliness and the frequency for nowcasting updating (especially if the estimates already start during the reference period). In case of the estimation of high frequency indicators it is important to define the frequency at which the indicator is expected to be estimated as well as some feasible targets in terms of timeliness. For new indicators it is essential to clearly define what they are supposed to measure, if they should be qualitative or quantitative as well as the expected frequency of computation and, if relevant, the timelines of production. For all the three cases presented above, it is essential also to specify if we aim to use big data together with other source of information or alone. 2.1.2 Recommendations

• Prepare a clear and detailed problem statement for each of the statistical problems to be addressed and solved,

• Clearly specify if big data are intended to be used as a complement of standard 6

information or as the only source of information.

2.2 Step 2: Implement a Modern and Efficient IT System to Host and Use Big Data 2.2.1 Description

There are several factors which indicate that specific hard and soft frameworks have to be designed for big data. The first one is obviously that they constitute a very large amount of information, not necessarily numerical. Such huge amount cannot usually be treated by standard database systems. The second factor is that big data are typically non structured while traditional database systems have been designed to host structured data in the form of time series, spatial series, panel or a combination of the above. Another factor is that traditional statistical and econometric modelling or exploratory techniques need to be adapted and improved to deal with such large amount of data often available at very high frequency. Consequently an efficient system able to collect, store and treat big data needs to be designed before thinking to use big data in any kind of statistical production. This new framework has to be complemented by a set of statistical and econometric tools for filtering, exploring, modelling and evaluating big data.

2.2.2 Suggestions

• Implementing a modern, efficient and flexible IT system for collecting, storing and treating big data of various nature and characteristics,

• Implementing a set of statistical and econometric tools specifically adapted to deal with big data,

• Use as much as possible existing IT solutions and well known and tested software applications, such as those available in Matlab and R packages.

2.3 Step 3: Big Data Usefulness 2.3.1 Description

The advantages of Big Data have been widely emphasized both in the general press and in more specialized journals, books, conferences and meetings. In a nowcasting context, Big Data can provide potentially relevant complementary information with respect to standard data, being based on rather different information sets. Moreover, it is timely available and, generally, not subject to subsequent revisions, all relevant features for potential coincident and leading indicators of economic activity. Further, it can provide a more granular perspective on the indicator of interest, both in the temporal and in the cross-sectional dimensions. In the temporal dimension, Big Data can be used to update nowcasts at a given frequency, such as weekly or even daily, so that the policy and decision makers can promptly update their actions according to the new and more precise estimates. In the cross-sectional dimension, Big Data could provide relevant information on units, such as regions or sectors, not fully covered by traditional coincident and leading indicators. Similar considerations apply to the case of the construction of high frequency

indicators. Concerning the construction of new indicators, it appears clearly that big data contains information concerning phenomena and events which are difficult to measure or to describe only based on the traditional information coming from surveys and so on. All these benefits should be however contrasted with the possible drawbacks, which are many but all controllable. Following the guidelines provided in this section should permit to form a reasonable expectation of the costs of Big Data and of whether it will lead to additional gains either in terms of nowcasting performance or of the possibility of better describing phenomena not accurately described by using official statistics sources. Obviously, the relevance and the usefulness of Big Data can vary across the kind of indicators domain and context so that they have to be checked in a case by case way. Finally, it is important to notice that the potential of Big Data, especially for constructing nowcasts or high frequency indicators, has to be evaluated either in terms of the ability of improving the precision of nowcasting at a given time lag or in terms of the possibility of producing timelier nowcasts without significant deterioration of their reliability.

2.3.2 Recommendations

• Suggest the use of Big Data only when there are well founded expectations of their usefulness either for fixing problems in existing nowcasts, or to improve the timeliness/accuracy of nowcasting, or to produce reliable and timely high frequency indicators or even new ones.

• Do not consider Big Data sources with doubtful or even spurious correlations with the target variable.

2.4 Step 4: Big Data Search 2.4.1 Description

The starting point for an assessment of the potential benefits and costs of the use of Big Data for macroeconomic nowcasting, construction of high frequency indicators and of new indicators is represented by the identification of their source and of the relevance of its information content for the target to be achieved. In Buono, Kapetanios, Marcellino, Mazzi and Papailias (2017) we have conducted an in-depth analysis of various categories of big data, trying to further disaggregate the UNECE classification, and, finally, we have identified a reasonably detailed classification based in 11 main groups. Each of the identified groups has its own characteristics, specificities and peculiarities. Some categories are highly unstructured while others are pretty structured; some are fully numerical, others not; some are very related to economic activities while others concern phenomena not necessarily clearly linked with them. In order to clearly analyze the relevance of big data for the construction of various kinds of indicators, let’s start from the aggregate UNECE classification. The first main provider is represented by Social Networks (human-sourced information), broadly defined to include proper social networks such as Facebook, Twitter, Tumblr etc., but also blogs and

comments, pictures (Instagram, Flickr, Picasa etc.), videos (YouTube, etc.), Internet searches, mobile data content (text messages, GPS positioning, user generated maps, etc.), e-mails. The associated data is, typically, loosely structured and often ungoverned. A second main source of Big Data are Traditional Business Systems (process-mediated data). These processes record and monitor business events of interest, such as registering a customer, manufacturing a product, taking an order, etc. The process-mediated data thus collected by either private or public institutions are highly structured and include transactions, reference tables and relationships, as well as the metadata that sets its context. Traditional business data are the vast majority of what IT managed and processed, in both operational and BI systems. Usually structured and stored in relational database systems, including also “Administrative data”, they can be further grouped into data produced by Public Agencies (medical records, social insurance, etc.) and data produced by businesses (commercial transactions, banking/stock records, e-commerce, credit cards, etc.). A third, fast expanding, provider of Big Data is the so-called Internet of Things (IoT, machine- generated data). These data are derived from sensors and machines used to measure and record the events and situations in the physical world. Examples include data from fixed sensors (home automation, weather/ pollution sensors, traffic sensors/ webcam, etc.) or mobile sensors (tracking: mobile phone location, cars, satellite images, etc.), or data from computer systems (logs, web logs, etc.). The well-structured nature of machine-generated data makes them suitable for computer processing, but their size and speed is way beyond traditional approaches. From an economic nowcasting point of view, all the three types of big data are potentially relevant. For example, selected internet searches and/or “ tweets ” 6 (Social Networks), credit card transactions (Traditional Business Systems), or number of navigating commercial vessels in a certain area (Internet of Things) could all provide useful leading indicators for macroeconomic trends such as inflation and GDP growth, see Buono, Kapetanios, Marcellino and Papailias (2017) for details. Almost the same applies to the case of constructing high frequency indicators, such as weekly or daily estimates of GDP. Concerning the construction of new indicators, there is no doubt that the internet of things can probably be the most relevant source, especially when considering quantitative indicators, while social networks data could be of particular interest when constructing qualitative indicators such as sentiment or climate ones. Overall, a crucial step for a proper use of Big Data for producing statistical information is a careful search and classification of existing data. A priori, it is very difficult to give general guidelines on a preferred data source because the choice is heavily dependent on the target problem we are facing with. Even if we are restricting the context to a very specific problem, such as nowcasting, it should be understood that several competing big data sources can be available a priori. Big Data users should be aware that the type of Big Data selected can heavily influence the whole exercise both in terms of Big Data handling and Big Data modelling due to their more or less unstructured typology and to their size.

6 Twitter - generated messages.

2.4.2 Recommendations

• Search in the wider possible set of Big Data having clearly in mind the specificities and the characteristics of the target exercise as well as what we want to estimate (a quantitative growth indicator for something not yet measured, a qualitative sentiment or climate one, the growth of an existing indicator, etc.).

• Check for the adherence of available Big Data to what the target variable, if any, is really measuring or what we aim to measure.

2.5 Step 5: Assessment of Big Data Accessibility and Quality 2.5.1 Description

Unfortunately, not all existing Big Data are also available. In fact, most data pass through private providers and are related to personal aspects. Hence, once a potentially useful Big Data source is identified it should be evaluated whether and at what cost the information is actually available. Besides availability, an additional issue is continuity of data provision, which could not be guaranteed. For example, Google could stop providing Google Trends, or at least no longer make them available for free. Or online retail stores could forbid access to their websites to crawlers for automatic price collection. Or, individuals could extend the use of softwares that prevent tracking their internet activities, or tracking could be more tightly regulated by law for privacy reasons. Continuity of data availability is more an issue for the use of internet data in official statistics, especially the construction of new indicators, than for a pure nowcasting purpose, as it often happens in nowcasting that indicators become unavailable or no longer useful and must be replaced by alternative variables. That said, continuity and reliability of provision are important elements for the selection of a big data source. A Big Data feature specifically relevant for our applications is the overall time span covered by big data. Unfortunately, the time span covered is often low, even if in high frequency or cross-sectionally there can be thousands of observations, as Big Data generation and collection has started only recently. A short temporal sample is problematic for nowcasting and for high frequency indicators, as the Big Data based indicators need to be related to the target low frequency macroeconomic indicators and, without a long enough sample, the parameter estimators can be noisy and the ex-post evaluation sample for the nowcasting performance too short. Also concerning the construction of new indicators, the short time span can be a problem since it prevents a proper evaluation of the adequacy and plausibility of the newly constructed indicator. On the other hand, several standard informative indicators, such as surveys and financial condition indexes, are also only available over relative short samples, starting after 2000, and this feature does not prevent their use. Moreover, panel studies using rather short time series but for many countries could be also informative and alleviate the need for long temporal Big Data samples. Furthermore, the availability of a good quality documentation or of a regularly updated metadata associated to Big Data must be viewed as an important characteristic when analysing and selecting available Big Data.

A final issue specifically relevant for Big Data nowcasting is the control of the stability of the relationship with the target variable. This is a common problem also with standard indicators, as the type and size of economic shocks that hit the economy vary over time. In the case of Big Data an additional potential source of instability is the fact that both their size and quality keeps changing over time, in general much faster than for standard data collection. For example, applications such as Twitter or WhatsApp were not available just a few years ago, and the number of their users increased exponentially, in particular in the first period after their introduction. Similarly, other applications can be gradually dismissed or used for different purposes. For example, the fraction of goods sold by EBay through proper auctions is progressively declining over time, being replaced by other price formation mechanisms. The instability of the relationships between the target variables and the Big Data can be seen as discriminants for the use of Big Data. Despite the fact that these aspects are mainly relevant for nowcasting, they can also affect somewhat the construction of new indicators. In particular, the change in the quality and size of certain big data over the time, can affect negatively the temporal consistency of new indicators and then their overall quality. 2.5.2 Recommendations

• Prioritising data providers which are able to give sufficient guarantee of the continuity of the data process and of the availability of a good and regularly updated metadata associated to the Big Data.

• Prioritising Big Data sources which ensure sufficient time and cross-sectional coverage to properly building up exercises such as nowcasting, construction of high frequency indicators and of new ones.

• In order to deal with possible instabilities of the Big Data either in relation with the target variables or over the time, models should be re-specified on a regular basis and occasionally in presence of unexpected events.

2.6 Step 6: Big data Conversion 2.6.1 Description

Even if available, there are often substantial costs to make the Big Data suitable for statistical or econometric exercises. Actually, big data often appear to be unstructured, so that a proper mapping into regularly spaced cross-sectional or time series observations is required. Data structuring and conversion is a difficult task, as the researcher is called to translate the unstructured data and summarise them into a format which is both meaningful and informative for the nowcasting exercise or for constructing high frequency or new indicators. In a first instance structuring and conversion rules apply to numerical big data but, after applying a quantification procedure, they can also be used on originally non-numerical one such as text data. For example, consider the use of internet search queries for nowcasting a specific indicator. This requires to select a given set of queries related to that indicator (including the country coverage, language, etc.), to collect information on the number of queries for each specific keyword in a given time span (e.g., in a day, week or month), and to aggregate all

the keyword specific queries into an index that, ideally, should lead to the specific target indicator. This topic is clearly relevant but not considered formally in the econometric or statistical literature on Big Data. We have proposed a method on how to formalize this transformation process of unstructured data in Buono, Kapetanios, Marcellino and Papailias (2017). There is no unique way to transform unstructured into structured data, as the specific transformation depends on the type of Big Data. However, most transformations can be treated in a unified analytical context, where they are considered as functions that map the Big Data into the real space. 2.6.2 Recommendations

• Ensure the availability of an exhaustive and well documented Big Data conversion process,

• Identify the most suitable structuring and conversion rule to be applied to the Big Data under investigation,

• For originally non-numerical big data identify and apply a sound, transparent and well documented quantification method that preserves the information content of the original Big Data.

2.7 Step 7: Big Data Cleaning 2.7.1 Description

Various types of big data are generally collected, stored, processed and disseminated by institutions, either private or public, which are not subject to the quality assurance framework imposed to the producers of official statistics. This means that big data are less strictly monitored so that they can include much more anomalies than traditional statistics. Furthermore the same nature of some big data, related to human activities or to automatic detection of phenomena, is associated to a high number of data irregularity due to errors, mismeasurement etc. By consequence, especially numerical big data, can be, even after the structuring and conversion phase, still affected by a high number of anomalies such as:

• missing data,

• presence of outliers,

• presence of transitory or permanent shifts,

• inconsistency of pattern over the time.

The presence of such elements can compromise the utilisation of big data sources in further modelling phases so that it is suitable to correct as much as possible such anomalies in order to obtain more regular time series with a minimum of anomalies. The anomalies mentioned above should be first identified, then understood and, whenever possible eliminated by means of robust statistical methods. Since the structuring and

conversion approach produces as output a set of time series, which are likely to be correlated, it is of high importance to conduct the identification, interpretation and correction phases in a multivariate context. In an ideal situation consistent methods to replace missing observations with acceptable values, to correct outliers and shifts should be as much as possible consistent and carried out in the same computational framework, such as the state-space one. 2.7.2 Recommendations

• Conduct an in-depth and possibly multivariate analysis of the anomalies and identify those to be corrected,

• Define a statistically and economically sound approach for dealing with all kinds of anomalies to be corrected.

2.8 Step 8: Removing Seasonal and other High Frequency Periodicities 2.8.1 Description

Since most big data are collected and recorded at high or even very-high frequency, it is likely that they are characterized by seasonal or other very short run periodicities. Furthermore it is also possible that they can be subject to calendar effects. For example, daily data can show the usual annual cycle (seasonal components) together with other minor cycles, such as weekly and monthly ones that are not, strictly speaking, seasonal since they do not match the annual cycle. Furthermore, for daily data most calendar effects appear to be seasonal so that no calendar adjustment is needed with the exception of that related to moving holidays. For weekly data the situation is similar, since they often show a 4 week cycle that does not match either the monthly or the annual cycle. For weekly data, the calendar adjustment is needed because the impact of different days of the week is not detectable. When dealing with nowcasting exercises, big data should be subject to a similar filtering process as the target variable, and the same also applies when constructing high frequency indicators. By contrast, when constructing a new indicator, the decision is more complex. In a first phase, it is essential to define the frequency at which the new indicator should be computed and published. In a second phase, if the indicator should be compiled and released at an infra-annual frequency, the components of the new indicator should be tested for the presence of calendar and seasonal effects. Finally, in case of the presence of such effects, it has to be decided if the new indicator should be presented raw, seasonally or seasonally and calendar adjusted, or both. Removing seasonal and other very short run periodicities is not a trivial operation since traditional seasonal adjustment methods cannot be applied like that but they need to be extended in order to deal with multiple non additive periodicities. This problem is treated extensively in Ladiray et al. (2018) and Kapetanios, Marcellino and Papailias (2017), to whom we refer for this specific step. Extending existing seasonal adjustment methods to deal with daily or weekly data is not trivial and presents different degrees of complexity depending on the methods. The extension is relatively easier for moving average based methods and more complex for methods based on the canonical decomposition of ARIMA models. Nevertheless the

generalization of the existing seasonal adjustment methods is probably the way to follow, since developing new ad hoc procedures will be resources consuming and it will create inconsistencies with the methods currently in use for monthly and quarterly data.

2.8.2 Recommendations

• Filter out seasonal and other high frequency periodicities as well as calendar effects, if any, in a consistent way with the reference variable in the nowcasting exercise or in the construction of high frequency indicators.

• For new indicators, if seasonal and other high frequency periodicities, together with calendar effects, have to be removed, then follow standard approaches properly extended to deal with high frequency data.

• Do not develop ad hoc solutions but invest in generalizing already existing seasonal adjustment methods.

2.9 Step 9: Bias Correction 2.9.1 Description

In this step we are considering the possibility of a bias in the signals provided by Big Data, due to the so-called “digital divide” or the tendency of individuals and businesses not to report truthfully their experiences, assessments and opinions. These phenomena are mostly characterizing internet based big data since the ”digital divide” assumes that not all age classes are equally represented in the internet population. In particular, older generations are supposed to be less present than younger ones. This problem can be generalized as, for example, not all classes of revenue are equally represented in the internet population. Furthermore, and this assumption tends to go beyond the internet based big data, it is likely that regions and countries with a different degree of economic development present also divergences in the coverage of automatic sensors and detectors so influencing the representativeness of the internet of things based big data. By contrast, the tendency of not reporting truthfully opinions and assessments is mainly restricted to the case of internet based big data, especially those originated by social networks. If not detected, such biases can potentially influence not only nowcasting exercises but also the construction of high frequency indicators and new indicators. However, once detected, the presence of bias can be tackled at the modelling and validation stages. 2.9.2 Recommendations

• If a bias in Big Data results is observed, provided that it has been reasonably stable in the last few years, a bias correction can be included in the modelling strategy,

• If a bias in the Big Data results is very unstable or too large, then Big Data should be considered not reliable enough to be used.

2.10 Step 10: Designing a Big Data Modelling Strategy 2.10.1 Description

Once temporally structured, properly cleaned and filtered, adjusted for seasonally and other infra- monthly periodicities, Big Data are available, we can proceed to identify and implement one or several proper econometric methods for the problem at hand, and conduct a careful in-sample and pseudo-out-of-sample evaluation (cross-validation) of the alternative methodologies. If a target variable is not specified, as in the construction of new indicators, the econometric techniques will mainly work to extract from big data, and eventually, other traditional statistical data, the common signal to derive the new indicator. We discuss in details modelling aspects in this step, while evaluation is treated in Step12 and Step 11 is devoted to the construction of indicators from unstructured big data. Big Data prevents the use of standard econometric methods. For example, when the number of regressors is larger than that of observations (N ≫ T , as in FAT datasets), OLS estimation clearly cannot be used, as well as OLS based statistics, such as t-tests and F-tests to check the significance of regressors. Moreover, selecting regressors by means of information criteria also becomes not doable, as 2N models should be compared, a number larger than one million already for N = 20 regressors. Furthermore, standard statistical theory to prove econometric properties such as unbiased and consistency of the estimators typically relies on fixed N and T diverging asymptotics (suited for TALL datasets, where T ≫ N). Instead, with big (potentially HUGE) data both N and T diverging asymptotics is needed, which is much more complex. While numerical Big Data is often associated with internet or IOT sources, as we have seen, in practice we have similar econometric issues also when pooling together standard economic indicators for many countries or sectors or firms or households, or with tick by tick data on selected financial transactions, which easily produces datasets with thousands of variables and/or thousands of observations for each variable. A common approach is to either aggregate the data or to impose strong a priori assumptions on the econometric models for the disaggregated data, e.g., in panel data models the effects of the regressors are typically assumed to be the same for all units, only intercepts can differ, and the units do not interact among themselves. Clearly, in general these assumptions are invalid, and data aggregation leads to a loss of information. Another alternative for Fat and Huge datasets is to split them into smaller ones, each with a limited N dimension, apply standard techniques to each sub-dataset, and then re-group the results. However, also in this case cross-datasets linkages can be lost, as well as efficiency. Hence, proper Big Data econometrics is needed. Big data econometrics has received a big boost in the recent past, more in terms of estimation and testing than forecasting. Kapetanios, Marcellino and Papailias (2017) review some of the many approaches available, which can be categorised in five main classes, which we now briefly summarize, providing guidelines on when to use each of them.

Machine Learning Methods In machine learning methods, which are particularly suited for FAT datasets, the starting point is to somewhat regularize OLS estimation to make it feasible also when N is very large. This is typically achieved by adding a set of (nonlinear) constraints on the model parameters, which are thus shrunk towards pre-specified values,

preferably towards zero in order to achieve a more parsimonious specification. This class includes methods such as Penalised Regression, Ridge Regression, LASSO Regression, Adaptive LASSO, Elastic Net, SICA, Hard Thresholding, Boosting and Multiple Testing. Unfortunately, few applications of these methods are available in the context of macroeconomic nowcasting and forecasting, and even fewer cross-method comparisons. Similar considerations apply to the case of constructing high frequency or new indicators. Furthermore the main hypothesis on which machine learnings methods are based, meaning the IID distribution needs to be relaxed in order to make them more suitable for applications in the macroeconomic context.

Heuristic Optimisation The rationale of Heuristic Optimisation is to use information criteria to reach a good balance between model fit and parsimony by assigning a penalty dependent on the number of model parameters (which is equal to that of regressors in the linear context). However, as mentioned, direct minimization of the information criteria is not doable when N is large, as the number of models to be compared is too large. Yet, the search for the best model could be restricted to specific regions of the vast model space, and Heuristic Optimisation provides methods for doing so. Within this class of algorithms, it is worth mentioning Simulated Annealing, Genetic Algorithms, and MC3. As the methods are iterative, and sometimes simulation based, they can become computationally very demanding when N is really large, say already about 1000. As they should be applied recursively in a macroeconomic forecasting context, not only for forecast evaluation but also for cross-validation, the computational aspect can become quickly prohibitive. However, in other contexts, e.g. for the construction of coincident and leading composite indexes; of high frequency and new indicators, these methods could be quite useful at the stage of indicator selection.

Dimensionality Reduction Techniques A third class of econometric methods to properly handle big data is based on the idea of reducing the dimension of the dataset by producing a much smaller set of generated regressors, which can then be used in a second step in standard econometric models to produce nowcasts and forecasts in common ways. There are naturally many ways to carry out dimensionality reduction, the most common are Principal Component Analysis and Partial Least Squares, which can handle TALL datasets, and Sparse Principal Component Analysis, which is also suited for FAT and HUGE datasets. Principal components were typically considered as statistical objects of little economic interest. However, recent research has shown that they can be also used as estimators for the unobservable factors in approximate dynamic factor models, where each of the large set of variables is driven by few (temporally correlated) common factors plus an idiosyncratic component, and there can be limited cross-sectional correlation among the idiosyncratic components. As factor models are often implied by economic theory, e.g., in DSGE models there are a few main economic shocks driving all variables, principal components have now also a stronger economic justification. However, they still have the feature of summarizing the information in a large dataset without targeting it to explain a specific variable, which could enhance the forecasting performance. Partial least squares permits to do this, with some additional computational costs. If in a nowcasting exercise these methods work as a first step of a two stages estimation method,

where the second is represented by a standard regression including as regressors the few common factors identified in the first stage, when constructing high frequency indicators, the second stage can be replaced by a temporal disaggregation method using few common factors as explanatory indicators. When constructing a new indicator we can assume that there is only a single stage procedure where the few identified common factors are combined to derive it.

Shrinkage Estimators and Bayesian Methods Shrinkage estimators typically regularize OLS estimation, making it feasible also when N is very large and larger than T , by adding a set of a priori constraints on the model parameters. The constraints induce a bias in the estimator but also reduce its variance. As a consequence, some bias is also introduced in the forecasts, but their efficiency can be improved. In a classical context, shrinkage can be obtained in various ways, including by means of stochastic constraints on the model parameters. However, Bayesian methods are more commonly used, where prior distributions on the parameters permit to achieve the desired level of shrinkage (besides allowing the user to incorporate a priori opinions on the relevance of each explanatory variable). Bayesian regression has indeed attracted much interest recently also among practitioners, mostly due to the advancements in computing power that make simulation methods substantially faster than twenty years ago. Still, for Bayesian regression to be doable in a big data context, we need analytical rather than simulation based estimators. This can be achieved with a proper choice of prior distributions for the parameters, which should be conjugate (in order to have analytically computable posteriors of the same type as the priors), and imposed with sufficient tightness to guarantee a substantial amount of shrinkage (as in the penalized regressions).

Nowcast Pooling Forecast pooling (or combination) has a long tradition of empirical success, and nowcast pooling is promising as well. Possible reasons for the good performance of forecast pooling may be model misspecification, model uncertainty and parameter non- constancy, which are attenuated by weighting. As these features are likely present when modelling with big data, forecast combination could be helpful also in this context. Hence, an alternative procedure in the presence of a big set of potentially useful leading indicators for the target variable of interest is to use a (possibly very large) set of small econometric models to produce nowcasts, one model for each of the N available indicator or small subset of them, and then to combine the resulting many nowcasts or forecasts into a single prediction. An additional benefit of this approach is an evaluation of the forecasting ability of each of the many available indicators, which is of interest by itself. Sophisticated techniques for forecast combination have been suggested recently, including Bayesian model averaging and information theoretic weighting. However, both methods can be hardly applied for computational reasons when the number of models (N in case of a model for each variable) grows large. Instead, simple weighting schemes, and in particular equal weighting, can be implemented also with very large N , and anyway with smaller N they often perform equally or better than more sophisticated alternatives. Combining and averaging methods are also used when constructing high frequency indicators by applying temporal disaggregation methods to a large number of models and

then combining either the results or averaging the models themselves. By contrast, due to the unavailability of a target or benchmark variable, such approaches have a little interest when constructing new indicators. Finally, it is worth mentioning that all these approaches for nowcasting with Big Data should be also modified to take into account the possibility of a different frequency for the target and the indicator variables. For example, GDP and its deflator are only available on a quarterly basis, while Google trends are released on a weekly basis, and other internet based indicators, such as credit card transactions, are in principle available in real time. A similar issue occurs with standard indicators, such as surveys or financial variables, and a number of alternative econometric methods to handle mixed frequencies have been developed. Among them, Unrestricted MIDAS or bridge modelling appear as the most promising approaches in the presence of Big Data, as they preserve linearity and do not add an additional layer of computational complex. Obviously the presence of data available at different frequencies is treated differently when the aim is constructing high frequency indicators. In such specific case temporal disaggregation techniques are used to either interpolate or distribute the low frequency target variable according to the high frequency pattern designed by the selected explanatory indicators including eventually also big data. 2.10.2 Recommendations

• In the absence of any a priori information on the relative performance of various techniques, as many methods as possible should be evaluated and compared in order to select the best performing one.

• Alternative modelling strategies should be compared also by looking at the balance between their complexity in computational terms and their empirical performance.

• In case of mixed frequency data, linear methods such as UMIDAS and, as a second best, Bridge, should be prioritised.

• Forecast combination and model averaging techniques, also when the mixed frequency aspect is present, can be used as an alternative to a large-scale comparison among competing techniques.

• When the target is to estimate high frequency indicators, regression based temporal disaggregation methods should be privileged, possibly in combination with variable reduction techniques such as principal components or partial least square regressions.

• When constructing a new indicator for which a target or benchmarking variable is unavailable, methods such as principal components or partial least square are mostly recommended.

2.11 Step 11: Modelling Unstructured Big Data 2.11.1 Description

When the conversion and structuring of big data into time-series of panel data is problematic or even unfeasible, it is still possible to work on the original unstructured data and try to extract some relevant signals and commonalities, especially useful for the construction of new indicators, mainly qualitative ones. By contrast, working on unstructured big data does not seem promising when dealing with nowcasting exercises or with the calculation of high frequency indicators. Working on unstructured data can be very time consuming and it also requires powerful IT equipment. Mainly exploratory techniques, such as data mining (and its extensions such as text mining) or data analytics can be used to find patterns, commonalities and to extract signals from the original Big Data. Based on the results obtained, it is then possible to construct a new indicator, mainly qualitative, which synthesises the outcomes of the techniques mentioned above. 2.11.2 Recommendations

• Using either data mining or data analytics methods, in a judgmental approach, to avoid the identification of unrealistic patterns and relationships should be a focus.

2.12 Step 12: Evaluation of Big Data Based Analyses 2.12.1 Description

As Hartford (2014) put it: “ ‘Big data’ has arrived, but big insights have not. The challenge now is to solve new problems and gain new answers – without making the same old statistical mistakes on a grander scale than ever.” This is the goal of this step: assessing in a critical and comprehensive way the contribution of Big Data for nowcasting an indicator of interest, to derive a high frequency indicator or to construct a new one. This can be done, whenever possible within a real-time or a quasi real-time simulation exercise, by answering a set of questions, that we discuss in the next subsections.

Is there a “Big Data hubris”? “Big data hubris” is the often implicit assumption that big data are a substitute for, rather than a supplement to, traditional data collection and analysis, see Lazer et al. (2014). In a nowcasting context, this is the case for studies that are purely based on Big Data indicators, for example trying to anticipate unemployment using Google Trends only. It is not surprising that Big Data indicators are useful when used this way, but their usefulness could be spurious. This problem is even more relevant when constructing high frequency indicators, especially at higher frequency than monthly, because in such situations, big data are the only non- financial information available. Similar situation characterizes the construction of new indicators, since the need of such kind of indicators, is generally due to the impossibility of measuring some phenomena by traditional source of information. To attenuate the Big Data hubris we should think, as mentioned, of Big Data based indicators as complements to existing soft and hard data-based indicators, include all of them in econometric models, and assess the marginal contribution of each type of

indicators. This evaluation should be conducted in an out-of-sample context, as in-sample Big Data can lead to overfitting. Various specifications including alternative combinations of traditional and Big Data based indicators should be used for nowcasting over a training sample, and their associated forecast errors evaluated and compared, for example in terms of mean squared and mean absolute forecast errors. As already mentioned the balance between traditional data source and big data can be very different among the three cases we are considering in this document and consequently also the relevance of this specific evaluation criteria can vary accordingly.

Is there a risk of “False positives”? This question can be reformulated as: can we get some Big Data based indicators that produce good results just due to data snooping? Similarly, can we get positive results because of model snooping, since we have seen that various econometric approaches are available? The risk of false positives is always present in empirical analysis and is magnified in our case by the size of data and number of models. Only a careful and honest statistical analysis can attenuate this risk. In particular, as mentioned, we suggest to compare alternative indicators and methods over a training sample, select the preferred approach or combine a few of them, and then test if they remain valid in a genuine (not previously used) sample.

Are correlations mistaken for causes when interpreting the results? Again, this is a common problem in empirical analysis that is exacerbated in a Big Data context. For example, a large number of internet searches for “ filing for unemployment ” can predict future unemployment without, naturally, causing it. Hence, we should abstain from a causal interpretation of the results, unless it can be sustained by economic theory and/or institutional considerations.

Is there instability in the nowcasting ability of specific Big Data based indicators? Or in the relationships between certain big data and a target variable if any Instability is a common source of errors in nowcasting exercise also with standard indicators. It can be due to a variety of reasons, such as the financial crisis, more general institutional changes, discontinuity in data provision, etc. In the case of Big Data, there are some additional specific reasons for instability, such as the increasing use of internet and what Lazer et al. (2014) labeled “Algorithm Dynamics ”, namely the continuous changes made by engineers to improve the commercial service and by consumers in using that service. This phenomenon can also negatively affect the construction of high frequency indicators while for constructing new indicators the situation can be rather different. In this last case it is more the instability of the relationships among the component of the new indicators which can affect is performance and reliability over time. Instability is indeed often ignored in the current big data literature, while it is potentially relevant, as we know well from the economic literature, mainly for forecasting exercises. Unfortunately, detecting and curing instability is complex, even more so in a big data context. However, some fixes can be tried, borrowing from the recent econometric literature on handling structural breaks.

2.12.2 Recommendations

• Conducting an in-depth real-time or pseudo real-time simulation of competing models in order to evaluate their relative performance.

• Models including Big Data should be preferred when they significantly lead to an improvement of the reliability and accuracy of the nowcasting at the same point in time.

• Models including Big Data should also be preferred when they allow for timelier nowcasting without any significant loss in terms of reliability and accuracy.

2.13 Step 13: Implementation of Big Data Based Nowcasting and Indicators 2.13.1 Description

In case the in-depth comparative analysis carried out in the previous steps suggests that the use of Big Data can improve the situation, the new models can be then implemented. The improvement of the situation can have different aspects: for nowcasting, either in terms of more precise results with a given timeliness or timelier results with a non-significant loss of precision; for the construction of high frequency indicators, a smooth pattern delivering non-contradictory signals with respect to the corresponding low frequency benchmarking variable; for the development of a new indicator, the possibility of obtaining reliable information on a phenomenon not previously measured or monitored. At the implementation stage, the institution in charge of producing statistics should take several relevant decisions. Concerning big data based nowcasting, such decisions are related to the number of the nowcasting rounds to be implemented and their scheduling. For example, it is possible to decide to publish just one nowcast (e.g., at the very end of the reference period or at the very beginning of the following one), to produce two nowcasts (e.g., one in the middle of the reference period and one at the very end), or to produce a sequence of nowcasts scheduled at weekly or even daily frequency. For high frequency indicators, the key decisions to be taken concern the frequency of the high frequency one as well as the kind of adjustment (E.G. seasonal calendar or both). For example, if the low frequency reference variable is available quarterly, the options for the high frequency indicators are monthly, weekly or daily, while if the low frequency indicator is available monthly, then options are weekly and daily. The seasonal treatment should be compatible with the one performed on the low frequency indicator. For new indicators the key decision will concern their computation and release frequency. This decision should be taken considering not only statistical aspects, such as the relative reliability of new indicators at different frequencies, but also user needs and the frequency at which similar indicators are available. Such decisions should take into account, among others, the possible trade-off between timeliness and reliability, the user needs, as well as some more institutional considerations. New Big Data based nowcasting and indicators should then be appropriately documented, making them as transparent as possible for the users. Such new early estimates and indicators should be pre-announced and the most appropriate dissemination strategy should be identified in order to avoid any kind of misinterpretations by the users.

2.13.2 Recommendations

• Implementing and publishing the most reliable nowcasts available either at the end of the reference period or at the beginning of the following one.

• Moving towards a daily or weekly update on nowcasting already during the reference period, only after detailed pros and cons analysis and a consultation of the most relevant stakeholders. • Implementing and publishing high frequency indicators at the frequency for which the reliability and the precision with respect to the low frequency reference variable are the best possible

• implementing and publishing new indicators choosing their release on the basis of statistical considerations as well as on user need and the frequency of similar indicators

• The new Big Data based nowcasting and indicators should be accompanied by clear metadata and widely available reference and methodological documentation.

3 CONCLUSIONS

In this paper, we have proposed an operational step by step approach for using Big Data as a complement to traditional information sources. We have considered three main cases: the production of early estimates of macroeconomic indicators (nowcasting), of high frequency indicators, and of new indicators not previously available. The proposed step-by- step approach and associated recommendations aim to facilitate the activity of experts and official statisticians involved in the evaluation of the big data usefulness for official statistics.

References

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