The World of Economic Indicators
Editor’s Note: The following article appeared in the March 2008 issue of Fiscal Notes.
Measuring the Economy’s Pulse
So you try to follow the business news. And you hear that durable goods are down, but unemployment claims are flat, and housing permits are falling, but manufacturer inventories are rising...and you still don’t know whether that’s good or bad?
Welcome to the world of economic indicators, the yardsticks—some straightforward, some arcane—by which governments, businesses and economists measure the health and pace of the economy.
Statistics have been used for centuries to get a handle on business conditions, but today a bewildering variety of economic data is available from governments, academics and private organizations.
Forward, Into the Past
Economic indicators generally fall into three categories.
Leading indicators indicate which way the economy is headed. Examples:
- Initial Claims for Unemployment–the number of workers filing for unemployment benefits after losing a job.
- Consumer Confidence Index–consumer expectations about the economy, as reflected by a survey of 5,000 U.S. households conducted by the Conference Board.
Coincident indicators show economic changes occurring right now. Examples:
- Gross Domestic Product – the value, expressed in dollars, of all goods and services produced in the nation in a specific year.
- Nonfarm Employment – the total number of wage and salary earners working in business, industry and government.
Lagging indicators reflect past economic events. Examples:
- Unemployment Rate – the percentage of the total labor force that is unemployed in a given month.
- Outstanding Commercial and Industrial Loans – the volume of business loans held by banks and “commercial paper” (unsecured obligations) issued by nonfinancial companies.
Sources: U.S. Bureau of Labor Statistics, Oregon Employment Department, the Conference Board, the Federal Reserve and Texas Comptroller of Public Accounts
Past, Present, Future
Indicators fall in three major categories: lagging, coincident and leading.
Lagging indicators are measures such as house foreclosures and bank failures that follow an economic downturn. You can use them to confirm and analyze past events, but not to predict future ones. “They are useful, though, to describe the past more accurately, and that helps us be more accurate about the future,” says Gary Preuss, an economist with the Comptroller’s Revenue Estimating Division.
Coincident indicators, such as total nonfarm employment, move with the economy; in a sense, they define it. They’re important because they provide the best available snapshot of current economic conditions, but like lagging indicators they have no predictive value.
Most public attention, however, is focused on leading indicators—statistics that can be used to predict the course of the economy down the road. “A leading indicator is basically a forecast item,” Preuss says. “It’s something that will tell you what’s going to happen six months from now, based on what we know today.”
Initial claims for unemployment, for example, represent a common and highly useful leading indicator that can signal the beginning of an economic slowdown. Obviously, the ability to predict the course of future economic events makes such indicators extremely useful.
“Leading indicators have a lot of influence on the stock market, mostly because stock prices depend not so much on what’s really happening as what people think is going to happen,” Says Preuss. “And they’re a planning tool for the federal government, which uses indicators in part to gauge where the needs for government services are going to be.
“If we’re heading into a recession, the government knows it may have to pour more money into welfare programs right now, for instance,” he said. “And it’s the same thing for business—should we to invest in this item now? Should we build a new plant, or hire more employees? Leading indicators can help answer those questions.”
Indices Point the Way
Leading indicators can be compiled into an index, which combines and weighs a number of statistics into a single measure. One of the most widely used of these is the U.S. Index of Leading Indicators, prepared monthly by the Conference Board, a private business research organization.
The U.S. index combines 10 variables, including measures such as new private housing permits, initial claims for unemployment insurance, stock prices and manufacturers’ new orders for consumer goods and material. Together, these factors have proven to predict the near future of the national economy with fairly consistent accuracy.
The Texas Comptroller uses its own version, the Texas Index of Leading Economic Indicators, to predict short–term trends in state economic activity (see sidebar). These are used in preparing the Comptroller’s state revenue estimates, which relies on Texas business activities subject to tax.
“The 10 components of our index are things that, over time, have tracked the Texas economy rather well,” said Preuss. “We chose components for the index based on which are best for forecasting. We threw out a lot of factors, too. You can do statistical tests to see how accurate each indicator has been. Some things are not predictive at all, while others correlate very highly.”
The various component indicators in the Texas index are changed only rarely–twice since 1988, according to Preuss. “The predictive ability of things doesn’t change that much, unless you have a really big shift in the economy,” he said.
But the relative weights assigned to each factor in the index are shifted periodically to reflect changes in the state economy. “A good example is oil prices,” Preuss said. “They used to correlate extremely well with where Texas was going—if prices went up, the economy went up. But now, with a much larger part of our economy not related to oil, it’s not as strong a predictor any more”—and its weight has been changed to reflect this.