ECONOMIC INDICATORS
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.
BIBLIOGRAPHY
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.
