Leading and Lagging Indicators: What They Are and Why They Matter
Economists, analysts, policymakers and investors take the economy’s temperature by examining regularly released data sets called economic indicators. There are all kinds of economic indicators — some tell you how many people are unemployed, what things cost, how much merchandise is being manufactured, how much money people are spending, how much they’re saving or even how they feel about their own financial prospects.
All of them, however, fall into one of three broad categories: leading, lagging and coincident indicators. Leading and lagging indicators are the most important.
Leading Indicators Make Predictions About What Might Happen
Leading indicators attempt to predict the coming phase of the business cycle (expansion, peak, contraction and trough), which is often called the “economic cycle” or “boom-bust cycle.” Leading indicators are especially important when the economy is heading into or out of a period of recession.
The five most important leading indicators are:
- The Yield Curve: This indicator uses data from short- and long-term interest rates on Treasury bills, bonds and notes to predict impending recessions with remarkable accuracy.
- Building Permits: This data predicts how new home construction will look in the future. That’s because cities issue home-building permits after the purchaser has signed a contract, but months before construction is complete.
- Durable Goods Orders: Unlike consumer durables like refrigerators and cars, business durable goods orders — like machinery and equipment — tell economists whether businesses are growing or contracting. That information helps them predict whether the economy will strengthen or weaken.
- Manufacturing Jobs: When manufacturers stop hiring, that means a recession is imminent. But when manufacturers are taking on new factory workers, it means that the economy is heading into a period of expansion.
- The Stock Market: The stock market is a good predictor for investors and analysts because a company’s stock price is a good indicator of that company’s expected future earnings.
Lagging Indicators Verify Trends That Are Already Happening
Lagging indicators are data sets that are compiled after something has happened. Unlike leading indicators, which try to predict future events, lagging indicators help economists establish trends by looking back.
A few of the most important lagging economic indicators are:
- Gross Domestic Product (GDP): GDP measures the combined market value of all finished goods and services produced in one year in the United States — although other countries, regions and individual states all have their own measurable GDPs. It is the best overall snapshot of the national economy and its rate of production.
- Unemployment Rate: Unemployment measures changes in the jobless rate from the month before. As a lagging indicator, those jobs have already been gained or lost by the time the report comes out, but it tells economists what to expect in the near future.
- Consumer Price Index (CPI): The CPI measures changes in the cost of goods and services, which makes it the most important way of gauging the rate of inflation.
- Consumer Confidence Index (CCI): Although some economists view the CCI as a leading indicator, most treat it as a lagging indicator — data that establishes a trend based on events in the recent past. It’s a survey that assesses how regular people feel about the job market and business climate in general. It’s usually a lagging indicator because, generally, those emotions don’t change until something happens in the economy to make them change.
- Interest Rates: Interest rates are determined by the federal funds rate, which only changes when market forces and/or economic events force a change.
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Keep in Mind
There’s a third class of economic indicators, which are not followed nearly as widely as lagging and leading indicators. They’re called coincident indicators, and they report what’s happening in the present. Among the most important are average weekly hours worked in manufacturing and real earnings.
This article is part of GOBankingRates’ ‘Economy Explained’ series to help readers navigate the complexities of our financial system.
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