Every single day, millions of buyers and sellers interact with one another each trying to optimize their own personal financial situation. In aggregate, this exchange of goods and services is what makes up our economy. The American economy is the largest economy in the world with some $10.6 trillion dollars worth of goods and services being produced, every year. Understanding how people and governments make choices in a world of scarcity is what economics is all about.

Each month, the federal government, or one of its agencies, releases an assortment of economic data points (economic indicators) that provide snapshots of various aspects of the economy. Investors, business owners, government officials and individuals scrutinize this data as it gives important clues to the overall health of the economy. Armed with the right economic data and a solid action plan, investors and business people can profit from this information by putting into action a strategy to capitalize on the future direction of the economy. Not only do investors and business people scrutinize this information, but so does the Federal Reserve (the Fed) who uses it to determine monetary policy.

Economists have discovered that individual economies aren’t static in nature, but rather they are subject to economic cycles. The basic economic cycle consists of four phases, which represent the rising and falling of economic growth. The four phases of the economy are: 1) expansion or recovery, 2) peak, 3) contraction or recession and 4) trough. Economists study these phases and look at the various economic indicators to try and gauge what phase of the cycle the economy is in and whether the future rate of economic growth is quickening or slowing.

Economic theory holds that it is expectations about the future and future profits that are the motivating force in the economy. When business executives feel optimistic about the future and believe that profits are going to rise, they invest in the economy by hiring staff and building capabilities to deliver future goods and services. On the other hand, when their expectations are falling, executives reduce production and investment. It is precisely these actions that generate the four phases of the business cycle.

The economic data points (indicators) that the government publishes every month help economists to determine which phase of the business cycle the economy might be entering. Some of the indicators are leading indicators in that they tend to predict where the economy is going. Others are considered lagging indicators because they tend to show up after a change from one phase to another has occurred. Lagging indicators also tend to give economists important clues as to the duration of economic upturns or downturns. While still others are considered coincident indicators since they coincide with a change in the economy from one phase to another. As well, coincident indicators provide information about the current status of the economy.

These indicators can be classified as follows:

Leading Indicators:

1. Average Weekly Hours – Manufacturing: Is watched because employers tend to adjust work hours before increasing or decreasing the size of the workforce.
2. Average weekly unemployment claims: This tends to be a very sensitive indicator of the business cycle. Claims rise when the cycle starts to fall.
3. Building Permits: Is an indication of construction activity, which typically leads other types of economic activity
4. S&P 500 Stock Index: This is a widely followed indicator since it reflects the general sentiments of investors and movements of interest rates which are good indicators of future economic activity.
5. Index of Consumer Expectation: Is an index that is constructed from monthly survey data that gives insights into consumer’s attitudes about future economic conditions
6. Money Supply: M2 – If the money supply does not keep pace with the overall level of inflation (rise in price levels) then this may make it more difficult for the economy to expand.
7. New Orders – Manufacturers (consumer goods): This is watched because a rise in new orders directly affects the level of both inventories and unfilled orders that firms monitor when making economic decisions.
8. Yield Curve (Interest rate spread): The yield curve is constructed using the federal funds rate (an overnight interbank borrowing rate) and the ten-year Treasury bond rate. This curve is widely watched since it gives an indication to the Feds’ stance on monetary policy and general financial conditions. In general, the curve is upward sloping (short term rates are lower than long term rates), however, when it is inverted, it is a particularly strong indicator of a recession.

Coincident Indicators:

1. Non-Farm Payrolls: This statistic gives an indication to the actual hiring and firing trends in the economy. It is an excellent barometer of economic conditions and is widely followed.
2. Index of Industrial Production: Is an index that measures the physical output of all stages of production in the manufacturing, mining as well as gas and utility industries.
3. Personal Income (in 1996 $): This is an important indicator since income levels help to determine the general health of the economy as well as the level of aggregate spending.

Lagging Indicators:

1. Average Duration of Unemployment: As an expansion starts to gain strength the average duration of unemployment tends to drop. After the start of a recession, the sharpest increases tend to occur.
2. Commercial and Industrial Loans Outstanding (1996 $): This number tends to peak after the expansion has peaked because declining profits usually result in an increased demand for loans.
3. Average Prime Rate Charged By Banks: The prime rate is the interest rate that banks charge their best customers. Changes in the prime rate tend to lag behind movements in the overall economy.
4. Consumer Installment Credit vs. Personal Income: This is a measure of the ratio of consumer debt versus income levels. In general, consumers tend to stop borrowing until after a recession ends. This tends to lag a rise in personal income by a year or longer.
5. Change in Labor Cost per Unit of Output (Manufacturing): During recessionary periods, this ratio tends to rise as output declines faster than labor costs despite layoffs of production workers.

Report on Money publishes a quarterly economic update that examines the key statistics affecting the economy and examines the likely direction of things to come. In addition, Report on Money examines the various benchmarks and indices that economists follow and analyze to help you keep abreast of the big picture. Click here for more information on the economy and how you can prosper from the upcoming changes.