Leading indicators precede economic output measures and are used to forecast economic activity. Coincident indicators coincide with the current level of economic activity. Lagging indicators lag behind the overall pace of economic activity and are backward-looking.
Leading indicators include average weekly manufacturing hours, average weekly initial jobless claims, manufacturer’s new orders, stock prices, and housing permits. Coincident indicators are data like industrial production or manufacturing sales. Lagging indicators are data such as the average duration of unemployment, commercial and industrial loans outstanding, and changes in the consumer price index.
Gross domestic product (GDP)
Gross domestic product (GDP) measures the market value of goods and services produced over a period of time. GDP measures the economic output of a country. A recession is defined as two consecutive quarters of negative GDP growth.
GDP is expanding when the GDP is higher for a period than the same period the previous year. GDP is contracting, or the economic activity of a country is declining, when the GDP is lower for a period when compared to the same period the previous year. GDP is an indicator of the standard of living for the residents of a country.
The two most commonly used measures of GDP are nominal GDP and real GDP. Nominal GDP is the dollar value of the economic output of a current year. Real GDP is nominal GDP adjusted for inflation. High inflation distorts a country’s nominal GDP and makes real GDP a more important indicator of economic growth than nominal GDP.
The business cycle refers to the cyclical rise and fall of economic activity in a country. The business cycle has four stages: peak, contraction, trough, and expansion. Expansion occurs during times of rising GDP, while contraction occurs during times of declining GDP.
Historically, the technical definition of a recession from an economic indicator perspective has been two consecutive quarters of decline in real GDP. Early expansion occurs as an economy begins to grow after a recession. As the expansion matures, growth declines, and the economy peaks.
Following the peak, an economy contracts as growth slows. The contraction continues through an economic recession until growth returns and the cycle repeats. The business cycle may also be referred to as the “boom/bust” cycle.
The yield curve is a graph depicting the relationship between interest rates and time to maturity. Interest rates are plotted from the shortest maturity to the longest maturity.
A positive slope means that long-term rates are higher than short-term rates, while the positioning of the line on the Y-axis shows the overall level of interest rates across maturities.
The yield curve typically shows short-term interest rates lower than long-term interest rates (positive slope). This relationship is a normal yield curve.
An inverted yield curve has short-term interest rates higher than long-term interest rates. A flat yield curve has relatively little difference between short-term and long-term interest rates. Investors typically require higher interest rates for longer periods, so a normal yield curve is upward sloping.
During times of economic uncertainty and changes in interest rate policy by central banks, the yield curve may invert as investor demand for the security of short-term investments increases.
The yield curve is used to gauge investors’ expectations for future economic growth. Lower short-term interest rates are generally associated with economic downturns. As short-term interest rates increase, the economic outlook is typically stronger.
Consumer price index (CPI)
The consumer price index (CPI) is a standard measure of consumer goods price inflation. CPI measures the average monthly change for a basket of goods and services bought by consumers. Components of CPI include food, transportation, shelter, utilities, clothing, medical care, and entertainment. Core CPI excludes food and energy from the index.
As the cost of the basket of goods in the index increases, CPI increases. Inflation is the percentage change in the CPI from one period to the next. Rising inflation may distort nominal GDP, so CPI is important to calculating real GDP. There is typically an inverse relationship between inflation and real GDP.
High inflation increases the cost of capital via higher interest rates. As the cost of capital increases, corporate borrowing decreases. Decreased borrowing tends to signal decreased corporate spending and less economic expansion.
The unemployment rate is the percentage of a country’s labor force that is unemployed but seeking employment. Each month, the unemployment rate is published by the Bureau of Labor Statistics (BLS) in the nonfarm payrolls report. The numerator of the unemployment rate is the number of unemployed persons currently seeking a job, while the denominator is the number of people in the workforce.
The headline, or overall, unemployment rate can be deceiving. Many elements of the nonfarm payroll report, aside from the headline unemployment rate, are important. The unemployment rate may rise because of an increase in the number of unemployed or because workforce participation declines. Labor force participation is the labor force divided by the nonmilitary working-age population. A decline in labor force participation may signal decreased economic output in the future.
Underemployed individuals are those with part-time employment but desire full-time employment. Underemployed individuals are, therefore, not producing economic output at their full potential.
Important wage and efficiency information come from the nonfarm payroll report as well. Average hourly earnings is an important indicator of potential inflation, and the average workweek for all employees is a significant productivity indicator.
Jobless claims represent the number of people filing claims to receive unemployment insurance benefits. Jobless claims are reported weekly.
Initial jobless claims measure the number of individuals filing for unemployment insurance for the first time in the past week. Continuing jobless claims are those who filed an initial claim and are receiving unemployment benefits. An increase in either initial jobless claims or continuing claims is a bearish economic indicator and indicates a potential increase in the unemployment rate.
Both initial claims and continuing claims may be relatively volatile, so many analysts use a four-week average to gauge employment trends.
Balance of trade
The balance of trade refers to the net difference between a country’s imports and exports of goods over a period of time. When a country exports more than it imports, the country has a favorable balance of trade.
Balance of trade should be considered when measuring a country’s export or import of services. Balance of trade is a component of a country’s current account, which is a primary component of a country’s balance of payments. The balance of payments also incorporates a country’s imports and exports of capital and foreign aid.
A favorable balance of trade often translates into a higher standard of living for a country because capital flows into the country as a result of the purchase of goods.