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Key Leading Indicators

Key Leading Indicators

Author: Kate Eskra

This tutorial explains key leading indicators.

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Source: Image of Business Cycle created by Kate Eskra, Graph of New Private Housing Units authorized by building permits St. Louis Federal Reserve PERMIT series, public domain, http://research.stlouisfed.org/fred2/graph/, Graph of S&P 500 Stock Price Index, St. Louis Federal Reserve SP500 Series, public domain, http://research.stlouisfed.org/fred2/graph/

Video Transcription

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Hi. Welcome to economics. This is Kate. This tutorial on the key leading indicators. As always, my key terms are in red and my examples are in green.

So in this tutorial, we'll be talking about how economists use data to study the economy. And I'll define and give some examples to you of the leading economic indicators. So this is a business cycle. It shows us that it's very normal for the economy to go through periods of growth and contraction.

You can see here that where our GDP or our output in the economy is growing, we're expanding. We hit a peak, and then we enter a brief period of contraction where GDP or output falls. Here's a trough, and then the cycle starts over.

If in fact a contraction lasts longer than about six months, most economists agree that we can call that a recession. Most people are concerned about things like the unemployment rate and inflation in the economy. But economists are going to use a lot of different kinds of data to help them do three different things.

First of all, they use some data to be able to predict where the economy is headed. They use other data to look at what has just occurred in the economy. And yet again, another kind of data is going to help them look at what is currently happening in the economy. For the purposes of this tutorial, we're focusing on what is going to happen soon, where is the economy headed.

So economists study economic indicators, which give them an overall view of the economy at any given point in time. The three categories are leading, lagging, and coincident. And here we're talking about leading. Leading indicators are trends, patterns, or are that assist in forecasting the economy.

So where is the economy headed, is the question. It's these leading indicators that are going to give us an idea of where we might be headed in the short run. Some examples of leading indicators are unemployment insurance claims, building permits, and stock or equity performance.

So let's talk about unemployment insurance claims first. When people lose their job from no fault of their own-- so this isn't them getting fired for doing something wrong-- they're entitled to collect unemployment insurance. Our Department of Labor releases a report each week which details state by state jobless claims and then compiles them.

Keep in mind that these are only people who have filed a claim. So this measure right here is not necessarily going to measure everybody who is unemployed, because not everybody who is unemployed is filing a claim to collect unemployment. So anyway, the Department of Labor then gives these week to week reports.

And they can be very volatile because of how short term this is. So generally speaking, what we see on the news or what we hear released in newspapers is it's reported as a weekly jobless claim. And that takes a four week average, because that's less volatile than week to week to week.

So how is it that consumers and firms might respond when they hear that unemployment claims have risen, let's say? Well, if consumers hear that a lot more people are filing unemployment claims, they might say, what if I'm next? Oh my gosh, I can't plan that vacation. I don't want to spend any extra money this paycheck. I have to save it all.

So they have less confidence spending money. And that's why this is a leading indicator, because it can actually cause the economy to go down from there. Firms can respond in the same way. They might see that people are losing their jobs.

They might assume that people won't have money to spend. And so they might scale back on production. So again, this is a very macroeconomic way of looking at things if we're looking at the overall number of people in the economy filing for unemployment. But it can be certainly applied to microeconomics, because sometimes certain industries experience different unemployment rates than others.

For example, if there's an industry that's having a lot of structural unemployment due to technological changes in that field, that can cause a very high unemployment rate in one industry compared to the others. And so microeconomists might look at how will a certain market be impacted by increasing or shrinking unemployment, how could a group of certain individuals be impacted by structural unemployment.

And so that's how microeconomists can look at this. Our second leading indicator for this tutorial are building permits. The government also collects data on the number of permits for new private housing units.

So almost all residential buildings in our country are built in places that require a permit to be issued in order to build it. And so every month, what our government does is they survey 9,000 selected permit issuing places to see the number of new private housing units being developed. So how can this help us determine anything?

Well, when these are on the rise, it really does suggest that people are confident. Again, if people are making the decision to build a house, to build a new house, then they're probably pretty confident in their stability of their job and in the future of our economy. To make some large purchase like that shows some confidence.

And the housing market is huge here with the economy, because it affects so many other markets. When you buy a new house, you need a lot of things for that house. We need to employ a lot of workers in different industries to finish your house. It could even impact the furniture market. People need furniture when they buy a new house or build a new house, people need new appliances.

So it can really affect a lot of other markets. And so microeconomists might actually be studying the impact of these individual markets and then expect future growth in those markets as these building permits begin to rise. They could also look at how future economic growth might impact certain groups of individuals.

Here you can see a graph of building permits. And I took this back to 1960. And any area here that's shaded in gray, as this indicates, it shows a recession in our country. And typically you can see that right after building permits started to fall, we did enter a recession.

That's what you can see that this is a leading indicator. Here building permits start to fall. And here we enter a recession. They begin to rise. And then we're out of the recession.

The last leading indicator is stock or equity market performance. And performance in our stock market really does tend to predict where our economy is headed. As the stock market begins to improve, that usually is an indication that we're on an upswing. If it starts to taper off, that sometimes unfortunately is an indication that we're headed for a contraction.

And that's because changes in stock prices reflect investors' expectations for the future. Instead of measuring every company in the stock market, which would be very time consuming and just kind of really a lot of information, the most common index that's used is called the S&P 500. That stands for Standard Poor's.

And this is 500 major companies-- so we're talking large companies here-- that are supposed to represent an overall picture of the stock market. And so it's not just companies in one kind of industry but across all industries, from things in utilities or telecom services, energy, information technology, financial, health care, you name it.

If it's a major, major company and it meets certain criteria, it can be included in the S&P 500. So when individuals hear that the SP is up, let's say on the news, they tend to be more confident about the economy. Especially investors tend to make more purchases and investors tend to make more investments.

Any time the stock market falls, people tend to be fearful of spending money right now. And so like I said, it does tend to predict where the economy is headed. A microeconomist might use this information to show where or how a certain kind of firm is going to be generating revenue.

And here you can see a graph again with the gray areas shaded here represent recessions. And you can see that right after the stock market falls, we enter a recession. Right after it begins to rise again, things tend to improve. Here we're in another recession and that followed right after a dipping of the stock market.

This is from 2000 on. So I wanted to show you a little bit more current then going back years and years and years for this one. So in this tutorial, we talked about how economists use data to study the economy overall and they use it to study individual markets. It's the leading indicators that give us an idea of where the economy is headed.

And those three leading indicators that we discussed here were unemployment claims, building permits, and stock market performance. Thanks so much for listening. Have a great day.

Notes on "Key Leading Indicators"

Terms to Know

Leading Indicators

Trends, patterns or situations that assist in forecasting the economy.