What Is the ZEW Indicator of Economic Sentiment?

The ZEW Indicator of Economic Sentiment is a simple sentiment indicator created out of the monthly ZEW Financial Market Survey. The ZEW Financial Market Survey is an aggregation of the sentiments of approximately 350 economists and analysts on the economic future of Germany in the medium term. ZEW stands for Zentrum für Europäische Wirtschaftsforschung, which translates to the Center for European Economic Research.

Understanding the ZEW Indicator of Economic Sentiment

The ZEW Financial Market Survey covers a number of areas, sectors, and regions, but only the questions related specifically to the German economy are used to create the ZEW Indicator of Economic Sentiment. From this data, a simple indicator reading is given showing the difference between the number of analysts that are bullish on the German economy versus those who are bearish. If the reading is a negative percentage, it means the majority of analysts are bearish. If the reading is positive, it means the majority is bullish.

For example, if 20% of respondents expect the German economic situation to deteriorate, 30% expect it to remain unchanged and 50% expect it to improve, then the ZEW Indicator of Economic Sentiment would have a positive value of 20. This is a bullish reading and suggests that financial experts see positive signs for growth in the medium term.

As it is a sentiment indicator, double-digit readings are not uncommon. In 2018, for example, the ZEW Indicator of Economic Sentiment went from a positive reading of 20.4 to -25 over a span of seven months. During this time, German economic growth slowed from 2.2% in 2017 to 1.5% in 2018, but the impact on the ZEW Indicator of Economic Sentiment somewhat overstated the severity of this slowdown—as sentiment indicators are known to do.

Sentiment Indicators

Economic sentiment indicators are a popular means of gauging and forecasting trends in the economy and the markets. Various economic theories support the use of such indicators, though they may otherwise disagree greatly in their assumptions and conclusions.

These include Keynesian economics, with its focus on investor and consumer psychology as (fundamentally irrational) driving forces of recessions and business cycles, and rational expectations theory, with its assertion that market participants in general use all available and relevant economic combined with a more-or-less accurate understanding of the structure of the economy to efficiently form rational expectations of future economic trends.

Sentiment indicators usually take the form of surveys of opinions or intentions toward future actions and economic trends among various groups of people in the economy. By surveying large numbers of people, sentiment indicators are geared to leveraging the wisdom of crowds. This is the idea that while individuals might often be mistaken, the average thinking of a large number of people aggregates more dispersed information and is likely to be more accurate.

The groups surveyed may include investors, CEOs, supply chain managers, small business owners, bank lending officers, or consumers. For example, a survey of consumer sentiment might ask a sample of consumers whether they feel optimistic about the economy and whether they plan to make any big-ticket purchases in the next six months. Some indicators are targeted at key participants who directly drive markets, such as consumers and investors, and some, like the ZEW Index of Economic Sentiment, are targeted at experts who are expected to have better-than-average insight into future economic trends.

The Data Behind the ZEW Indicator of Economic Sentiment

As mentioned, the ZEW Indicator of Economic Sentiment takes the aggregate of around 350 economists' and analysts' sentiments to get a sense of Germany's economic future. These experts come from banks, insurance companies, and the financial departments of selected corporations. They are asked about their expectations for the coming six months, regarding the economy generally, inflation rates, interest rates, stock markets, exchange rates, and oil prices.

The Index itself is calculated as the percentage of experts who are optimistic regarding Germany's economy in the next six months minus the percentage who are pessimistic for the German economy over that time period.

In addition to the questions about the German economy, the ZEW Financial Market Survey covers the economic futures of several other countries and regions, including Japan, the United States, the eurozone, the UK, France, and Italy.