Economic Indicators
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 Indicators
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.
Lagging Indicators
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.
Inflation
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 __BODY__.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.
Consumer Price Index
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.
