The health of the economy is often a big focus in news headlines, but why all the attention? The answer is both simple and complex. In our free enterprise system, the state of the economy can make a big difference in our daily lives. It affects opportunities in the job market, drives the stock market, determines prices and influences buyer behavior.
When the economy is robust, there’s optimism in the air. Companies hire, investors invest and consumers tend to spend more freely. Conversely, when the economy is sluggish, the mood is more somber. Companies struggle to make a profit, investors are more cautious and consumers tighten their wallets.
How do we know if the economy is doing well?
Because so many activities contribute to the economy, it can be hard to get a handle on where it is headed. Economic indicators that go hand-in-hand with economic health provide clues. Direct economic indicators go up when the economy is rosy and go down when the economy tanks. Other factors have an inverse relationship with the economy. These inverse factors fall and rise opposite the strength of the economy.
Leading economic indicators are considered the most important factors to watch. Unlike lagging economic indicators that appear after economic change, these indicators tend to come first, helping economists predict the direction of the economy. Here are some of the most often discussed leading economic indicators to put on your radar.
Consumer Price Index
The Consumer Price Index (CPI) is a consolidated measure of the price of goods and services over time at the consumer level. Observed changes in CPI help determine inflation (rising prices) and cost of living (how much it costs to get by) and help shape our monetary policy. Measured by the Bureau of Labor Statistics, the CPI is calculated for food, energy and all other consumer goods. Further analysis within these categories can reveal what influences price fluctuations.
The prices of some goods and services are more influential than others. For example, because we are a nation of automobile owners, the price of gasoline is closely watched. When prices get too high or too low, the government may intervene with policies intended to cap consumer costs and spur economic activity.
Producer Price Index
While the Consumer Price Index looks at prices paid at the store, the Producer Price Index (PPI) considers what wholesalers pay for U.S. goods and services (less food and energy, which are not factored into this equation). Because wholesale prices influence consumer prices, PPI can be a useful predictor of impending inflation.
U.S. Import and Export Price Indexes
Our nation relies on foreign trade to sustain economic activity. Therefore, the price we can charge our foreign trading partners for goods and services can reveal a good deal about our economic standing. Fluctuations in supply and demand, competition and the stability of our global partners make these measures all the more vulnerable to variability.
Productivity and Costs
How productive are our factories? How efficient are our processes? Productivity statistics tell an important story for those who want to predict how well our economy is working. When businesses are able to do more in less time, profits rise, which in turn paves the way for more investment, more jobs and overall prosperity.
The real earnings economic indicator looks at real average hourly earnings to estimate consumer buying power. By comparing real earnings to the Consumer Price Index, economists can shed light on just how far the American dollar can go.
Housing starts and building permits are regularly monitored by the financial industry because they reflect both business growth and consumer confidence.
The stock market tends to perk up at the announcement of new hires and fewer unemployment claims. Investors like a healthy economy, where able-bodied workers can find good jobs. Job security also tends to give consumers more confidence.
What can you do with your improved understanding of leading economic indicators? Keep an eye out for trends reported in the news. If you want to do a deep dive, visit the websites for the Bureau of Economic Analysis and the U.S. Census Bureau for free reports of economic indicator data. Apply what you learn in a discussion with your financial advisor, who can help you consider important financial decisions that might be affected by a shift in the economic outlook.