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Lagging economic indicators offer a valuable perspective on the economic landscape. Unlike their forward-looking counterparts, leading indicators, lagging indicators focus on what has already transpired in the economy. They confirm past economic trends, providing insights into the impact and sustainability of those changes. Let’s delve deeper into what lagging economic indicators are, explore key examples used in the United States, and uncover how they can be utilized to gain valuable insights into the economic landscape.
What are lagging economic indicators?
Lagging economic indicators, unlike their crystal ball counterparts (leading indicators), don’t attempt to predict the future. Instead, they confirm what’s already transpired in the economy. Imagine them as the rings of a tree trunk, each layer revealing a year of growth or decline. By analyzing these indicators, we gain valuable insights into the impact and sustainability of past economic trends.
Confirming past trends: Lagging indicators move after economic activity has changed. So, if the economy has experienced a period of expansion, lagging indicators will eventually reflect that growth.
For instance, a consistently high unemployment rate lagging behind a reported increase in GDP (Gross Domestic Product) might suggest the new jobs created are not enough to absorb all available workers in the labor force.
Conversely, a decline in economic activity will be confirmed by lagging indicators, such as a rise in business loan delinquencies, which reflects companies struggling to meet their financial obligations after a period of economic slowdown.
Distinguishing from other indicators: It’s important to differentiate lagging indicators from leading indicators, which attempt to forecast future economic direction based on present trends, and coincident indicators, which offer a real-time snapshot of the current economic climate.
Lagging economic indicators provide valuable insights into the impact and sustainability of those past economic trends. For example, a significant rise in the Consumer Price Index for Services (a lagging indicator) following a period of economic growth suggests inflation might be a future concern, potentially impacting consumer spending power.
Informing policy decisions: Policymakers can use lagging economic indicators to evaluate the effectiveness of past policies, such as stimulus packages or interest rate adjustments. By understanding the impact of these policies on lagging indicators like employment or inflation, policymakers can make informed decisions about future economic interventions.
Limitations to consider
It’s crucial to remember that lagging economic indicators have a built-in delay. They react slowly to economic changes, so they might not provide immediate insights. Additionally, they should be used in conjunction with other economic data for a more comprehensive picture. By combining lagging indicators with leading indicators and coincident indicators, we gain a well-rounded understanding of the past, present, and potential future of the economy. This allows us to make informed decisions as students of economics, investors, or simply individuals navigating the ever-changing economic landscape.
Examples of lagging economic indicators in the United States
Lagging economic indicators, unlike their real-time counterparts (coincident indicators), offer a window into the aftermath of economic activity. They reveal the impact and sustainability of past economic trends, acting as echoes of what has already transpired. Let’s explore some key lagging economic indicators used in the United States:
The unemployment rate
This widely recognized indicator reflects the percentage of the labor force that is actively seeking work but unable to find employment. It’s a classic lagging indicator because businesses typically lay off workers after a period of economic decline.
Conversely, during economic expansion, it takes time for businesses to hire new employees and fill open positions. So, a high unemployment rate lagging behind a reported increase in GDP suggests the new jobs created haven’t been enough to absorb all available workers. This could be a sign of a fragile recovery.
Inventory levels
Businesses constantly monitor their stock of goods (inventory). Changes in inventory levels, particularly the inventories-to-sales ratio, offer insights into how businesses are adjusting to past economic trends. Here’s the logic:
Economic expansion: During economic booms, businesses might struggle to keep pace with rising consumer demand. This can lead to a decline in inventory levels as they sell more goods than they can produce or restock quickly. A low inventories-to-sales ratio suggests businesses are operating with lean inventories, potentially indicating they’re confident about continued strong demand.
Economic decline: Conversely, during an economic downturn, consumer spending weakens. Businesses might find themselves with a surplus of unsold goods. This can lead to a rise in the inventories-to-sales ratio as they struggle to sell existing stock. A high ratio suggests businesses are experiencing weak demand and might need to cut production or resort to discounts to clear out excess inventory.
Labor costs
Labor costs, specifically labor cost per unit of output, reflect the average cost of producing a single unit of good or service. This metric acts as a lagging indicator because wage adjustments typically happen after economic changes. Here’s how it works:
Economic expansion: During economic growth, businesses might be willing to increase wages to attract and retain skilled workers. Additionally, rising output due to increased production can help spread fixed labor costs across more units, leading to a slower rise in labor cost per unit of output. However, if wages rise faster than productivity, the cost per unit can still increase, potentially leading to future inflation pressures.
Economic decline: Conversely, during a recession, businesses might resort to wage freezes or even layoffs to reduce costs. This can lead to a decline in labor cost per unit of output in the short term. However, if the economic downturn is severe and leads to widespread business closures, it can also disrupt supply chains and ultimately contribute to future inflation.
Commercial and industrial loans
This indicator reflects the total amount of outstanding loans and commercial paper (short-term debt instruments) issued to businesses by banks and other non-bank institutions, adjusted for inflation.
Businesses tend to borrow more money to invest in expansion, inventory, or hiring during periods of economic growth. However, the approval process for these loans can take time. As a result, the peak in commercial and industrial loans often lags behind the actual peak in economic activity.
Conversely, during economic downturns, businesses might struggle to repay existing loans and become more cautious about taking on new debt. This can lead to a decline in commercial and industrial loans, but again, with a lag compared to the initial economic slowdown.
Consumer installment credit to personal income ratio:
This ratio compares the total amount of outstanding consumer installment credit (debt repaid in regular installments, like car loans or personal loans) to the total personal income of individuals in the US.
Consumers typically feel more confident about taking on debt when they’re experiencing economic stability and rising incomes. This can lead to an increase in the consumer installment credit to personal income ratio.
However, qualifying for new loans or credit lines can involve a credit check and income verification. So, the rise in this ratio might lag behind the actual economic expansion.
Conversely, during economic downturns, consumers might become more cautious about borrowing and prioritize paying off existing debt. This can lead to a decline in the ratio, but again, with a delay compared to the initial economic slowdown.
Consumer price index for services (CPI for services)
This specific index tracks the average price changes for a basket of services consumed by households in the US, including items like haircuts, transportation, rent, and entertainment. It’s a sub-index of the broader Consumer Price Index (CPI), which includes both services and goods.
Changes in service prices can be a lagging economic indicator for a few reasons. First, service providers might be hesitant to raise prices immediately during economic growth for fear of losing customers.
Additionally, some service costs, like rent or cable bills, might be locked into contracts, meaning price adjustments might only occur after the initial economic expansion has been underway for some time. Conversely, during economic downturns, service providers might be reluctant to lower prices due to potential profit margin pressures. This can lead to a slower decline in the CPI for Services compared to the overall economic slowdown.
The lagging indicator advantage: Applications in the real world
While lagging economic indicators might not offer a crystal ball view of the future, they hold significant value for various stakeholders navigating the economic landscape. Here’s how investors, policymakers, and even everyday individuals can utilize these echoes of the past:
Investors
For investors, lagging economic indicators offer valuable insights for making informed investment decisions:
Gauging trend sustainability: A strong economic expansion reflected in lagging economic indicators, like a low unemployment rate, might suggest a healthy environment for investments. However, a persistently high inventories-to-sales ratio, even amidst reported growth, could indicate potential overproduction and a future slowdown. This could signal caution for investors who might want to adjust their portfolios towards less cyclical stocks.
Identifying future inflation pressures: Rising labor costs per unit of output, a lagging economic indicator, could be an early warning sign of potential inflation down the road. Investors can use this information to consider inflation-hedged investments like Treasury Inflation-Protected Securities (TIPS) to protect their purchasing power.
Policymakers
Policymakers rely on lagging economic indicators to evaluate the effectiveness of past economic interventions and shape future economic policies:
Assessing stimulus impact: After implementing a stimulus package during a recession, policymakers can track lagging economic indicators like unemployment rates. A significant decline in unemployment following the stimulus suggests the policy might have been successful in creating jobs and boosting economic activity.
Identifying areas for further action: if lagging economic indicators, like consumer credit delinquencies, remain high despite economic growth, it might signal that certain segments of the population haven’t fully recovered. This could prompt policymakers to consider targeted policies to address these specific issues.
