Lagging Economic Indicator
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Definition of Lagging Economic Indicator:
Lagging economic indicators are economic data that are published after an economic event. They are used to confirm economic trends.
Investors may choose to sell a stock after learning that GDP increased less than the expected rate. GDP is a lagging indicator because it is reported after the growth took place. This example confirms that the economy is not as robust as the investor believed.
In contrast, leading economic indicators usually precede the economic event. They are used to predict the economy’s direction. For example, economists consider new building permits a leading economic indicator for the housing market because builders must secure a permit before they begin construction. If there is an increase in permits, the housing market will likely pick up. But building permits don’t guarantee an immediate increase in the housing market. Real estate sales is a lagging indicator because the sales have occurred when reported. An increase in real estate sales would confirm that the housing market is picking up.
The US Conference Board includes seven data series when it publishes a lagging indicator index monthly.
- Average Prime Rate: The prime rate is the lending rate banks charge their best customers. Many consumer and business loans are tied to prime. Bankers know the state of the economy in their community. When business is thriving, the demand for loans is high, and they raise their rates. Conversely, they may lower their rates to attract businesses when activity slows. Usually, bankers want to maintain their margins and reduce their rates after the peak of a business cycle. But when the economy is just beginning to expand, bankers usually seek loans and are slow to raise their rates.
- Ratio, Consumer Installment Credit Outstanding to Personal Income: Typically consumers acquire more debt at the beginning of a recession because they need money to pay their bills as their incomes decrease. However, consumers are slow to accumulate debt at the beginning of an expansion because they remain cautious, even though their incomes are beginning to rise.
- Change in Consumer Price Index for Services: Businesses respond to changes in their profit margins sooner than changes in the business cycle because peaks and troughs are not immediately apparent. A fall in the economy’s aggregate demand reduces profit margins at the beginning of a recession. Service providers typically increase their prices to maintain their margins. However, as the recession deepens, businesses will lower their prices to attract buyers and continue to do so into an expansion.
- Ratio, Manufacturing and Trade, Inventory to Sales: Following a peak in the business cycle, inventories rise as aggregate demand slows and sales fail to meet expectations. Conversely, inventories decrease when sales begin to pick up at the beginning of an expansion as companies use inventories to meet their sales. The ratio typically reaches its peak during the middle of a recession.
- Commercial and Industrial Loans: Following a peak, profits begin to fall, and businesses borrow more. But as the recession progresses, banks become more hesitant to lend. Usually, lending activity doesn’t start to increase until almost a year after reaching the trough.
- Change in labor cost per unit of output, manufacturing: Generally, this index is indirectly related to manufacturing. It takes time and money to attract and retain employees. Companies may be slow to hire early in an expansion. They want to be sure the recession has ended. They can also rely on the unused capacity inflicted by the recession. It may also be challenging to find qualified workers. During recessions, manufacturers are slow to lay off workers, hoping the downturn will be short and hoping to avoid rehiring and training new employees. Peaks in this index typically occur during a recession because companies are slow to lay off workers as manufacturing falls.
Average Duration of Unemployment: Businesses are generally slow to hire and slow to rehire. The demand for labor usually remains robust shortly after a peak, so the duration of unemployment doesn’t begin to increase until economic growth slows. The period of unemployment begins to shorten after a trough because formerly discouraged workers recognize the economy is improving and return to the job market. Companies also start to replenish their labor force.
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