Understanding Economic Indicators | CFA Level I Economics
In this lesson, we will conclude our discussion on business cycles by exploring economic indicators. We will delve into the differences between leading, coincident, and lagging indicators, as well as how to utilize them effectively.
Types of Economic Indicators
There are three types of economic indicators:
- Leading indicators: Change direction before peaks or troughs in the business cycle, helping strategists and businesses anticipate cyclical turns.
- Coincident indicators: Change direction at roughly the same time as the peaks or troughs, confirming the economy’s current phase.
- Lagging indicators: Change direction after expansions or contractions have already begun, as seen in the unemployment rate.
Market research organizations, like the Conference Board in the United States, compile leading, coincident, and lagging indicators for major economies. Some notable components include:
Leading Indicators
- Average weekly initial claims for unemployment insurance: A sensitive indicator of initial layoffs and rehiring.
- ISM new order index: A decline in new orders can indicate weakness in demand.
- S&P 500 index: Stock prices anticipate economic turning points, offering early signals on economic cycles.
Coincident Indicators
- Non-farm payrolls: Businesses adjust full-time payrolls in response to recession or recovery, reflected in this indicator.
Lagging Indicators
- Inventory-to-sales ratio: As businesses are slow to stock up on inventory, this ratio tends to lag the business cycle.
- Commercial and industrial loans: Frequently support inventory building, so this indicator lags for similar reasons as the inventory-to-sales ratio.
- Change in consumer price index (CPI): Inflation adjusts to the cycle late as producers are slow to change prices.
Organizations also publish aggregate indexes, such as the Index of Leading Economic Indicators and the OECD’s Composite Leading Indicators, which gauge the business cycle’s state in various countries and regions.
Analyzing Economic Indicators
As an analyst, follow these guidelines when studying economic indicators:
- Don’t rely on just one or two individual indicators. Confirm your conclusions with the aggregate index or other individual indicators.
- Study all three types of indicators to build a stronger case for determining the business cycle’s phase.
- Remember that classifications as leading, coincident, and lagging indicators reflect tendencies, not exact relationships. Changes in direction don’t always correspond to changes in the business cycle, and lead times may vary.
EXAMPLE
Based on the following indicators for the last two months, determine which phase of the business cycle the economy is most likely in and explain your rationale:
Answer: The last two indicators are lagging indicators. Both the CPI and loans data are in expansion, suggesting that the economy was expanding. Nonfarm payroll is a coincident indicator. We can observe that there is a change in direction from positive to negative. This could suggest that the economy has peaked.
And the first two indicators are leading indicators. The data for both months have been negative. Both indicators suggest that economic contraction is imminent.
So, taken together, all these data seem to suggest that the business cycle may be at or just past its peak.
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