Lagging, Leading, And Coincident Indicators

BIBLIOGRAPHY

The index of leading indicators comprises economic indicators that generally turn down and up prior to the business cycle peaks and troughs designated by the Business Cycle Dating Committee of the National Bureau of Economic Research. The index of coincident indicators consists of data series whose turning points tend to coincide with peaks and troughs in overall economic activity, and the index of lagging indicators comprises indicators whose turning points generally occur after recessions and recoveries begin.

The three indexes are published by the Conference Board, a not-for-profit business-membership organization. Prior to 1996, they were published by the Bureau of

Economic Analysis (BEA) of the U.S. Department of Commerce.

The ten components of the leading index are:

1. The length of the workweek for production workers in manufacturing.
2. Initial weekly claims for unemployment insurance.
3. Manufacturers’ new orders for consumer goods and materials.
4. A measure of slower deliveries by vendors.
5. Manufacturers’ new orders for nondefense capital goods.
6. Permits issued for the construction of new housing units.
7. Stock prices.
8. The inflation-adjusted money supply.
9. Consumer expectations.
10. The difference between the interest rate on ten-year Treasury securities and the federal funds rate, which banks charge one another on short-term loans.

Various explanations have been offered for why these indicators turn up and down before the economy does. Stock prices, for example, are regarded as a reflection of people’s confidence in the economy, and such confidence (or the lack thereof) is self-fulfilling. If people think the economy will do well, they will behave in ways (e.g., spending more freely) that will cause the economy to do well. Also, changes in stock prices create changes in wealth that—with a lag—lead to changes in consumer spending.

While the leading index is intended to predict cyclical turning points in the economy, it has major weaknesses as a forecasting tool. One weakness is that the time period between the turn in the index and the turning point for the economy varies greatly, before both recessions and recoveries. In 1993, when the BEA revised the index, it reported that the lead time provided by its new index had varied in the post–World War II (1939–1945) period from five months before the July 1953 peak to twenty months before the August 1957 peak, and that the lead time provided by the index that was being replaced had varied even more—from two months before the recessions that began in 1981 and 1990 to twenty months before the August 1957 peak. Under a widely accepted rule of thumb that a decline in the index is not meaningful until it has lasted at least three months, the leading indicators failed to signal the recessions that began in 1981 and 1990. Also, the index sometimes gives a false signal of a recession, as in 1984, when a large drop in the index was not followed by a downturn in the economy.

The BEA has pointed out, too, that the size of a drop in the leading index is not a sign of the severity of an ensuing recession; a mild recession may be preceded by a sharp drop in the index, and a severe recession may be preceded by a moderate decline in the index.

The coincident index includes:

1. The number of employees on nonagricultural payrolls.
2. Inflation-adjusted personal income less transfer payments (such as unemployment insurance benefits).
3. Industrial production (a measure of the output of the manufacturing, mining, and utility industries).
4. Inflation-adjusted manufacturing and trade sales.

The index is regarded as a gauge of the current health of the economy, although in the “jobless” recovery from the recession that ended in November 2001, payroll employment did not hit its low until August 2003.

The index of lagging indicators comprises:

1. The average duration of unemployment (inverted).
2. The ratio of inventories to sales in manufacturing and trade.
3. The change in labor cost per unit of output in manufacturing.
4. The average prime rate of interest charged by banks.
5. Commercial and industrial loans outstanding (adjusted for inflation).
6. The ratio of consumer credit outstanding to personal income.
7. The change in the consumer price index for services.

These series measure the types of forces (debt burdens, for example, and price and credit pressures) that build up during expansions and that can bring an expansion to a close if they build up excessively. Thus, the ratio of the coincident index (which measures economic activity) to the lagging index serves as a leading indicator of recessions. A decline in the ratio during an expansion, suggesting that expansion-threatening forces are building up faster than economic activity is increasing, is a leading indicator of a possible recession.

The Conference Board publishes cyclical indexes for a number of countries other than the United States, and the makeup of those indexes differs somewhat from that of the U.S. indexes. For example, the coincident index for Mexico includes retail sales and the (inverted) unemployment rate, and the leading index for Australia includes the sales to inventories ratio.

SEE ALSO Business Cycles, Real; Equity Markets; Industry; Inflation; Inventories; Leisure; Maximization; Misery Index; Money, Supply of; Stock Exchanges; Unemployment; Unemployment Rate; Utility Function

BIBLIOGRAPHY

Frumkin, Norman. 2004. Tracking America’s Economy. 4th ed. Armonk, NY: Sharpe.

Green, George R., and Barry A. Beckman. 1993. Business Cycle Indicators: Upcoming Revision of the Composite Indexes. Survey of Current Business 73 (10): 44–51.

Stekler, H. O. 2003. Interpreting Movements in the Composite Index of Leading Indicators: Use Them with Caution. Business Economics 38 (3): 58–61.

Edward I. Steinberg