ECONOMIC INDICATORS

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ECONOMIC INDICATORS

• William B. Stronge Ph.D.
• Florida Atlantic University

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Economic RecessionsContractions

• Traditional definition two quarters of
  declining real GDP.
• Business Cycle Dating Committee looks at a
  variety of variables including employment.

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Decline of Business Cycle Theory

• Measurement without theory
• Cycles are irregular
• Only two recessions since 1982.

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Economic Indicators

• Developed to forecast the turning points of the
  business cycle.
• Based on monthly data.
• Leading indicators designed to predict economic
  recessions
• Coincident Indicators designed to move
  concurrently with the business cycle
• Lagging indicators designed to follow behind the
  cycle.

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History of Economic Indicators

• Developed at National Bureau of research in the
  1930s.
• Published by the US Bureau of Economic Analysis
  in BCD 1961.
• Published by the Conference Board since 1995
  (tcb-indicators.org).

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Coincident Indicators

• Used by the Business Cycle dating Committee to
  identify peaks and troughs.
• Employment
• Production
• Personal income
• Manufacturing sales
• Trade (wholesale and retail) sales

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Leading Indicators

• Average weekly hours
• New orders
• Consumer expectations
• Building Permits
• Stock Prices
• Interest Rate Spread

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Lagging Indicators

• Inventory-sales ratio
• Change in unit labor costs
• Average prime interest rate
• Commercial and industrial loans outstanding
• Consumer credit to income ratio
• Price of consumer services
• Average duration of unemployment

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Composite Indexes average the indicators

• The percentage changes in the components of the
  indexes are weighted by the inverse of their
  standard deviations.
• Similar to standardizing variables
• Lowers the importance of series that are volatile
  and increases the importance of stable series
• Result is expressed as an index.

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Diffusion indexes

• The percentage of the total number of components
  in a composite index that have moved in the same
  direction as the index.
• How widespread is the movement shown in the
  composite index?

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Use of the Indexes

• Coincident indicators are used to decide whether
  a turning point in the business cycle has been
  reached.
• Leading indicators are designed to predict
  turning points especially recessions.
• Lagging indicators confirm turning points and
  may indicate structural imbalances

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Predicting A Recession With The Index of Leading
Indicators

• Rule of thumb a decline of three months in a
  row forecasts a recession.
• Requiring duration reduces false signals which
  are frequent.

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The Three Ds

• Duration
• Depth
• Diffusion

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Modern Approach

• Economy is subject to ups and downs but there is
  no regular cycle
• Economy is subject to shocks negative or
  positive.
• Examples of negative shocks are
• Stock market crash in 2000
• 9-11
• Collapse of Housing Bubble 2006
• Credit Crunch 2007

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Demand Shocks

• Declines in investment due to collapses of
  bubbles
• Declines in consumption due to 9-11
• Declines in exports loss of Japanese tourism in
  Hawaii in 1990s
• Usually accompanied by recession and diminished
  inflation

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Supply Shocks

• Increases in oil prices in 1970s
• May be due to political instability among oil
  producers
• Pipeline leaks
• Poor agricultural harvests
• Ethanol demand for grains
• Usually accompanied by inflation and, maybe,
  recession

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Policy Responses to Shocks

• Monetary policy is key. Fiscal policy is too
  slow.
• Fed has responsibility to keep inflation low and
  also to keep the economy out of recession
• Fed can use monetary policy to achieve this most
  of the time.
• When shocks occur much depends on Fed policy
  response

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Predicting and Interpreting the Fed

• Fed (FOMC) controls, but does not set, the
  federal funds interest rate
• Federal funds interest rate is set by banks when
  they borrow from each other.
• Fed can squeeze the banks by selling bonds
  forcing an increase in the demand for federal
  funds.
• FOMC meets every 6 weeks or so.
• FOMC issues a statement at end of meeting
• Minutes published some weeks later.

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The Taylor Rule

• Target Fed funds rate 2.5 current inflation
  ½ inflation gap ½ output gap
• Inflation Gap inflation minus target rate (2)
• Output gap (real GDP potential real
  GDP)/potential real GDP expresses as