ECONOMIC INDICATORS. The indexes of leading economic indicators are statistical measures applied to evaluate the performance of the American economy. Also known as "business indicators," they are used to analyze business and economic trends with the aim of predicting, anticipating, and adjusting to the future. The index is made up of three composite indexes of economic activity that change in advance of the economy as a whole. The index is thus capable of forecasting economic downturns as much as 8 to 20 months in advance, and economic recoveries from between 1 and 10 months in advance. The economic indicators are not foolproof, however, and have on occasion suggested the opposite of what actually came to pass.
The Historical Background
In one form or another, economic indicators, however crude, have been in use since World War I. Until the Great Depression of the 1930s, economists devoted little effort to measuring and predicting economic trends, other than perhaps to compile statistical information on annual employment. With the onset of the depression, the importance of economic indicators grew, as the crisis made evident the need for businessmen and politicians to have detailed knowledge of the economy. As a result of the depression, business and government alike clamored for a more accurate measurement of economic performance.
A group of economists at Rutgers University in New Brunswick, New Jersey, developed the first official national economic indicators in 1948. Since then, the indicators have evolved into the composite index of economic indicators in use as of the early 2000s. The list of economic indicators was first published by the U.S. Department of Commerce, Bureau of Economic Analysis (BEA). Overall, the department has a noteworthy record: since 1948 the BEA has accurately predicted every downturn and upswing in the American economy.
Although economists are divided on the value of the index in predicting trends, businesspeople and the American public consider it the leading gauge of economic performance. Although the list of economic indicators has been revised many times to reflect the changes in the American economy, within a few years of its inception reporters began regularly citing information from the index in their writing about the American economy. In an effort to improve the accuracy of reporting on the economy, the BEA began issuing explanatory press releases during the 1970s. Considered crude gauges compared to the more complicated econometric models that have since been developed, the indexes of the BEA are still referred to by economists, the business community, and others interested in economic conditions and tendencies in the United States.
The Evolution of the Economic Indicator Index
After years of analyzing business cycles, the National Bureau of Economic Research created a number of indicators to measure economic activity, categorized into three general composite indexes. The first group is known as the leading indicators because its numbers change months in advance of a transformation in the general level of economic activity. The National Bureau of Economic Re-search uses ten leading economic indicators, which represent a broad spectrum of economic activity. These indicators include the average number of weekly hours of workers in manufacturing, the average initial weekly claims for unemployment insurance and state programs, new orders for manufacturers of consumer goods that have been adjusted for inflation, vendor performance, manufacturers' new orders for nondefense capital goods also adjusted for inflation, and new private housing units that indicate the future volume of the housing market and construction. Included also are the stock prices of 500 common stocks based on Standard and Poor's 500 Index, the M-2 money supply, which consists of all cash, checking, and savings deposits, interest rates along with ten-year Treasury bonds, and consumer expectations as researched by the University of Michigan.
Using this cluster of indicators, the Bureau predicts the national economic performance in the coming months based on a "diffusion index," or DI. The DI number at any given time is the percentage of the ten leading indicators that have risen since the previous calculation. A DI number greater than fifty indicates an expanding economy; the larger the DI number, the stronger the basis for predicting economic growth.
The remaining two indexes that are also consulted include the composite index of coincident indicators and the lagging index. The composite index of coincident indicators measures the current economy based on the number of employees on nonagricultural payrolls, personal income, industrial production, and manufacturing and trade sales. This index moves more in line with the overall economy. The lagging index does not react until a change has already occurred in the economy. This index consists of the average duration of unemployment, the ratio of manufacturing and trade inventories to sales, changes in the index of labor costs per unit of output, the average prime rate, outstanding commercial and industrial loans, the ratio of outstanding consumer installment credit to personal income, and any changes in the Consumer Price Index. Economists generally believe that lagging indicators are useless for prediction. The value of construction completed, for example, is an outdated indicator, for the main economic effect of the construction occurred earlier when the plans were made and construction actually carried out.
Other Economic Indicators
In addition to the composite indexes, there are other indicators that economists use to study the American economy. The Survey of Current Business, published by the U.S. Department of Commerce, is a quarterly volume addressing national production and the patterns of economic fluctuation and growth. The monthly Federal Reserve Bulletin provides measures of the national productive activity based on data from 207 industries. Also included are separate production indexes for three market groups: consumer goods, equipment, and materials, and for three industry groups, manufacturing, mining, and utilities.
Detailed statistics on the state of labor in the United States are contained in the Monthly Labor Review, which is published by the U.S. Bureau of Labor Statistics. Analysts and policymakers use the indicators of population, labor force size, and the number of employed workers to interpret the growth of national productive capacity. The index also provides the number and percentage of unemployed workers, the average number of hours worked, and the average earnings, all of which prove invaluable during periods of recession.
Other economic indicators include the monthly Consumer Price Index, which measures the general price level and prices charged by certain industries. Stock price averages are also evaluated. These consist of the four Dow Jones averages, which are calculated from the trading prices of 30 industrial stocks, 20 transportation stocks, 15 utility stocks, and a composite average of 65 other stocks. The Standard and Poor's composite index of 500 stocks serves as a leading economic indicator, as do the stocks traded on the New York Stock Exchange. The Federal Reserve supplies the additional indicators of money and credit conditions in the United States, covering the money supply, the amount of currency in circulation, checking account deposits, outstanding credit, interest rates, and bank reserves.
The Effectiveness of Economic Indicators
Over time, economic indicators have greatly increased the level of sophistication in economic forecasting and the analysis of business performance. The usefulness of these indicators, however, depends as much on the user's knowledge of their limitations as on the indicators themselves. Indicators provide only averages, and as such record past performance. As some economists have pointed out, applying indicators to predict future developments requires an understanding that history never repeats itself exactly.
Skeptical economists have warned that each new release of the leading economic indicators can trigger an unwarranted reaction in the stock and bond markets. They believe that the so-called flash statistics, as the monthly release of the leading economic indicators is known, are almost worthless. In many cases, the indicator figures are revised substantially for weeks and months after their initial release, as more information becomes available. As a result, the first readings of the economy that these indicators provide are unreliable.
One oft-cited example is the abandonment of the stock market that occurred during the final weeks of 1984. Initial statistics based on the leading indicators showed that the economy was slowing down; the Gross National Product (GNP) was predicted to rise only 1.5 percent. Further, statistics pointed to a worse showing for the following year. Certain that a recession was imminent, investors bailed out of the stock market in late December. In the following months, revised figures showed that the GNP had actually gained 3.5 percent, almost triple the initial prediction, an announcement that sent the stock market soaring.
The impact of current events can also play an important and unpredictable role in determining the leading economic indicators. In the aftermath of the terrorist attacks on New York and Washington, D.C., which took place on 11 September 2001, the leading indicators showed an unemployment rate of 5.4 percent, the biggest increase in twenty years. Included in that were 415,000 agricultural jobs that were lost during September, which was double the number analysts expected. The jobless rate also included 88,000 jobs lost in the airline and hotel industries, as well as 107,000 temporary jobs in the service sector. An additional 220,000 jobs were lost in unrelated businesses, pointing to an economy in distress.
Carnes, W. Stansbury, and Stephen D. Slifer. The Atlas of Economic Indicators: A Visual Guide to Market Forces and the Federal Reserve. New York: Harper Business, 1991.
Dreman, David. "Dangerous to your investment health; here are some good reasons you should stay clear of 'flash' economic indicators." Forbes 135 (April 8, 1985): 186–187.
The Economist Guide to Economic Indicators: Making Sense of Economics. New York: John Wiley & Sons, 1997.
Lahiri, Kajal, and Geoffrey H. Moore, eds. Leading Economic Indicators: New Approaches and Forecasting Records. New York: Cambridge University Press, 1991.
"Lengthening shadows; The economy." The Economist (November 10, 2001): n. p.
Rogers, R. Mark. Handbook of Key Economic Indicators. New York: McGraw-Hill, 1998.
Individuals and families have checking accounts, savings accounts, credit cards, and bills, so people make budgets to determine how much money they are making and spending. Businesses do the same thing. Countries, such as the United States, also use a budget to keep close track of their finances. The study of money and where it is going and where it came from is called economics. The economy is the system through which money circulates. Economists are the people who study the movement of money through the economy. By looking at economic indicators (which are features of the economy that are represented in numbers) economists make predictions about the potential strengths and weaknesses in the economy. Economic indicators give economists valuable insights into a country's financial standing.
Leading economic indicators are those that have the ability to forecast the probable future economy. An example of a leading indicator is the length of the workweek; that is, the average number of hours employees work in a week. As business increases, employers generally increase the number of hours that current employees work instead of immediately hiring new employees. A longer workweek tells economists that businesses are doing well. If business is increasing, the economy is doing well. If, on the other hand, the economy is doing poorly, employers will shorten their employees' work-week before laying off employees, a measure which is, for most employers, used only as a last effort to save money. Since the workweek lengthens or shortens before any effects on the economy are seen, a change in the length of the workweek in either direction can be used as a forecasting tool for economists.
Other economic indicators result from changes in various features of the economy. An example of a lagging indicator is the unemployment rate, which is the number that represents the percentage of the labor force that is not employed. The labor force is defined as all people over 16 years of age who are able to work. However, it does not include stay-at-home mothers or fathers, students, people who cannot work because of their health, or people who are not looking for jobs. If many people are unemployed, the economy is doing poorly. If few people are unemployed, the economy is doing well. Since change in the unemployment rate tells how many people either lost or gained jobs, it simply describes what has already happened; it does not predict what might happen.
Numbers in the Economy
Most of the numbers used to calculate economic indicators come from the U.S. Census Bureau, which is the division of the U.S. Department of Commerce that keeps statistics, such as the unemployment rate, the workweek length, the number of new houses being built, the number of building permits being given out, the number of new jobs being created, as well as many other figures. All of these statistics are used to provide economists with the data they need to study the economy. Economists are most concerned with changes in these statistics, which raises questions such as "Are there more new jobs being created this year than last year?" or "Are people working fewer hours this month than last month?"
The numbers for economic indicators are often put into indexes. Indexes are combinations of data from different economic indicators. The index numbers provide a broader view of the economy. One of the most frequently used numbers is the index of leading economic indicators (LEI).
This index measures changes in several leading economic indicators. An increase in the LEI for 3 or more months signals that the economy is improving; a decrease in the LEI for 3 or more months suggests a possible recession. A recession is a temporary decrease in business and therefore a downturn in the economy.
Gross Domestic Product
One of the best indicators of the economy is the gross domestic product (GDP). This dollar figure is the value of all goods and services produced within a nation in a calendar year. The gross national product (GNP) is also a dollar figure, but differs in that it is the value of all goods and services produced by a nation's citizens within a year. For example, the profits from an American-owned business operating in Germany would be included in the GNP, but not in the GDP because the business is not within the United States. The gross domestic product (GDP) is more commonly used as an economic indicator.
Goods that are included in the GDP must be newly manufactured items, and they must be finished products. In making an automobile, first a manufacturer makes the steel and sells it to the auto manufacturer. At this stage the steel is not counted in the GDP because it is not a finished product. The steel is counted in the GDP only as part of the value of the finished automobile.
The goods and services counted in the GDP consist not only of the things that people buy: They can be things that people produce that get consumed without ever being sold. One example is a farmer who milks cows. If the farmer then drinks some of the milk he or she produces, it is still counted in the GDP, even though it was never sold. Economists will guess at its market value (its worth) and add it to the total GDP. If milk sells for $2.50 per gallon at the time and it is estimated that the farmer's family drank 100 gallons of milk during the year, $250 would be added to the GDP. In this sense, the GDP is not a precise measurement.
Information for calculating the GDP is collected every quarter (i.e., every 3 months). The GDP in each quarter is multiplied by 4 to calculate an "annual GDP." Economists often adjust the GDP even further. Since seasonal changes affect the economy, economists often make adjustments for the seasons of the year. In the summer, for example, tourism increases and more money is spent. Instead of saying that the GDP is higher in the summer, economists adjust it so it is standard throughout the year. They do this by looking at the change in the GDP over several summers. For example, if the average change every summer is an increase of 3 percent, but one summer it increased 5 percent, it will only be said to have increased 2 percent above "normal."
Because prices fluctuate from year to year, another adjustment must be made to the GDP in order to allow economists to compare GDPs from different years. Most products, such as cars, homes, and clothing cost more now than they did 20 years ago. Therefore a dollar today purchases a different amount of product than it did in the past. To account for this, economists calculate each year's GDP in constant dollars. Constant dollars measure the value of products in a given year based on the prices of products in some base year. For example, in the early-1990s, economists used 1983 as a base year to convert to constant dollars. When economists refer to constant dollars, the base year is often stated. By doing this, the change in the GDP from year to year is due to the change in the amount of goods and services being produced.
Economists use the inflation rate to help them adjust the GDP to constant dollars. Inflation is the rate, expressed as a percentage, at which prices of goods and services are increasing each year. It may be reported on the news that "in March prices increased 1 percent, an annual inflation rate of 12 percent." The annual rate is calculated by multiplying the rate for the month times 12. But the annual rate of inflation for that year will only be 12 percent if prices continue to increase 1 percent per month for the rest of the year. Inflation rates may also be given as "the year's inflation." This does not mean an annual rate but a rate since January of that year. In the preceding example, the months included would be January, February, and March. It is important to understand the concept of inflation as well as the means by which it is reported.
The following example converts the GDP in 1980 to constant 1972 dollars. First, think of the base year (1972) prices as 1.0. By 1980, prices in the United States had increased to 1.8, an 80 percent increase since 1972. The GDP (in 1980 dollars) in 1980 was $2.62 trillion dollars. To change this to 1972 dollars, divide it by 1.8. This gives the constant dollar GDP of $1.45 trillion. This number is significantly lower than the current dollar GDP of 1980. However, it allows economists to compare the economy from year to year more accurately.
Inflation is determined by the Consumer Price Index, which is a measurement of price increase. Surveyors from the U.S. Labor Department collect information from households around the country about what goods are being purchased and consumed. Beyond knowing how much a household is spending, for example, on groceries or entertainment, analysts determine how much is being spent on specific items, such as eggs, milk, and movie rentals. All of the information collected from the surveyors is then averaged. The result provides the Labor Department with a representative budget for an average household.
The surveyors then price all of the items that are in that representative budget every month. They can compare the prices each month to find out how much they have changed. The rate at which they change is inflation. It is important to recalculate the consumer price index periodically because of the changing habits of consumers.
These economic indicators are only a few of the many that economists study every day. However, these indicators are the ones that are most often reported to the public and the ones that most directly affect consumers. For example, inflation rates, which may affect the interest rate a consumer must pay on a car loan or mortgage, are used to adjust interest rates. As inflation rates rise, so do interest rates, thus affecting consumers' purchasing power. A basic understanding of economics and economic indicators is essential in sound financial management.
see also Agriculture; Stock Market.
Kelly J. Martinson
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