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By Paul W. Henry
The tangible effects of the recession are obvious to everyone, and discussions of key economic indicators are no longer relegated to the back pages of specialty journals, but are cropping up around water coolers and at lunch tables across the country. These discussions are often characterized by a misunderstanding of what the key economic indicators actually measure. In an attempt to keep the debate concerning the direction of the economy informed, we offer the following discussion of some of the more commonly referenced key economic indicators.
An economic indicator is a measure, or statistic, that provides insight into the health and stability (or instability) of the economy as a whole. Generally, there are three types:
Coincident Indicators provide insight into the present health of the economy. Just as the cheers of the crowd signal a long fly ball at a baseball game, a coincident indicator tells us what is going on in the economy now. Gross Domestic Product (GDP), the total value of goods and services produced in an economy during a given period of time, is the most commonly cited coincident indicator. Higher GDP in a given period indicates more economic activity during that period.
Leading Indicators provide insight into future economic conditions. Leading indicators measure trends that generally foretell a predictable economic outcome. Interest rates are an example of a leading indicator. As interest rates decline, the supply and availability of money expands, resulting in an overall expansion of the economy. The opposite happens when interest rates rise; the supply and availability of money contracts, and it becomes more difficult for businesses to make capital investments and for consumers to borrow money, resulting in economic contraction in future periods.
Lagging Indicators provide insight into the past. Economists look to lagging economic indicators to confirm trends in economic activity. The unemployment rate is a commonly cited lagging indicator. Because it takes time for firms to react to changes in economic conditions by dismissing current workers or by hiring additional ones, the current unemployment rate is the result of economic conditions that occurred in the recent past.
It is important to consider the type of indicator when drawing conclusions about the direction of the economy. For example, it would be incorrect to argue that economic conditions are getting worse because unemployment is up. A rise in unemployment tells us that the economy was getting worse.
While the unemployment rate is considered a lagging indicator, economists consider Weekly Initial Jobless Claims a coincident or even leading indicator, because it measures the number of people newly unemployed. It provides insight into the direction of the economy based on the number of jobless claims filed by individuals seeking to receive state jobless benefits. While the unemployment rate is somewhat slow to react to changing economic conditions, the number of people newly laid off reacts quite quickly.
Other commonly discussed economic indicators include:
Real GDP, like GDP mentioned above, is a measure of the value of all the goods and services produced in an economy over a period of time. The difference between real GDP and nominal GDP is that nominal GDP is based on the prices that prevailed during the time the goods and services were produced, while real GDP is adjusted for the prices that prevailed during some other period of time. Real GDP allows better comparisons of economic activity between time periods characterized by different overall price levels.
Stock market indicators are useful leading economic indicators, because the financial markets tend to react more quickly than the economy as a whole to changes in economic conditions. The Dow Jones Industrial Average (DJIA) is an index of the stock price of 30 large U.S. companies. While its original constituents were all firms involved in heavy industry, today the DJIA includes such non-industrial stocks as Bank of America, Home Depot, McDonald’s, and Wal-Mart. Many people believe that the DJIA reflects the performance of the heavy manufacturing sector in the U.S., but this is no longer the case. The S&P 500 is an index of 500 large capitalization stocks of U.S. companies traded on the NYSE and NASDAQ. It is considered a broader indicator of the overall level of stock prices than the DJIA. The NASDAQ Composite Index is an index of over 3,000 securities traded on the NASDAQ. It includes stocks of U.S. companies, REITs, limited partnership interests, and ADRs. Many people believe the NASDAQ tracks the technology sector or small businesses in general, but the companies included in the NASDAQ vary widely in size and industry.
Decosimo Advisory Services prepares a quarterly summary of national economic conditions for the benefit of our clients and friends. To subscribe please visit www.decosimo.com/subscribe.
By Paul W. Henry
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