Economic analysts rely on indicators to judge the overall health of an economy. Leading indicators are used to predict economic movement, coincident indicators show current activity in a specific area, and lagging indicators are the most used as they are seen after an activity has occurred. While there are many indexes that can be used to gauge economic health, the six major economic indicators are the consumer price index, gross domestic product, employment figures, real estate sales, interest rates, and the stock market.
As it is speculative by nature, the stock market is a major leading indicator used to predict where the economy is headed. Stock prices are based on educated guesses of the institutional-money managers who manage mutual and hedge funds for public and private investors. With this in mind, the stock market is regarded as a predictor of the future health of the economy. If the money managers believe the economy is headed in the wrong direction, they will liquidate stock shares and put the money in safer places. Conversely, if the managers feel optimistic, they will heavily invest in stocks and the market goes up.
Gross Domestic Product (GDP)
Gross domestic product (GDP) is a measurement of all the goods and services produced in a country over a given period of time. GDP is a coincident indicator as it is used to measure the current value of produce, or “final” goods and services, meaning what is bought by the end user. Because it is composed of all goods and services produced for sale and includes education and defense services provided by the government, GDP is seen as one of the most accurate economic indicators.
Consumer Price Index (CPI)
The consumer price index, often referred to as CPI, is the most widely used measure of inflation as it references the rise or fall of the cost of consumer goods and is one of the major indicators of government policy effectiveness. The consumer price index is used by business leaders and private citizens as a guide when making economic decisions. The CPI and its components are used to measure price changes and adjust tax structures. It then attempts to translate those changes into inflationary free dollars.
Employment numbers are one of the most significant lagging indicators used to gauge the health of the economy as it indicates how many people are, or are not, earning money to feed back into the economy. The total employment number is calculated based on new unemployment claims over the past quarter as well as the last 12 months. A rise in unemployment signals that trouble is brewing as those consumers will not have as much money to buy goods and services.
Interest rates are raised and lowered by the Federal Reserve Bank in response to a variety of factors that includes an interpretation of the other economic indexes. The “Fed” will lower rates when the economy requires stimulation and raise rates during times of inflation to reduce the amount of money in circulation.
Real estate numbers, including new home sales and the home prices index, are lagging indicators as these are reported for the previous three months. Strong new-home sales numbers mean that people are earning enough money to buy new homes, and the interest rates are low enough to make both the buyers and lenders feel secure. However, the home prices index is a national average and will vary greatly by area. For example, the cost of living in North Carolina is substantially less than in New York City.
While utilizing these indexes is important in interpreting the health of the economy, indicators are just that and only useful when interpreted correctly. Indices are often used to give the appearance of a boom or bust depending on what an annalist is trying to show. Therefore, the best solution in gauging the health of the economy is to research the data yourself and make informed conclusions based on information from several unique sources.
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