Uses and Limitations of Economic Indicators

Different economic indicators are used in different stages of assessing the business cycle of an economy. There are three broad categories of indicators, namely, leading indicators, lagging indicators, and coincident indicators.

Leading indicators tend to change direction before the cycle goes into expansion at the trough or before contraction at the peak. They can be used to make predictions about events in economy and tend to change ahead of that event. The housing market, retail activity, inventory levels and sales are some examples of leading indicators.

A lagging indicator is an indicator that follows an event. Lagging indicators can only give insights using historical patterns. CPI, unemployment rates, balance of trade, interest rates, income and wages and the value of the currency are examples of lagging indicators. Unemployment rate (lagging) indicates that the economy has been doing poorly. Similarly, financial statements are lagging indicators.  They show the result of spending.

Coincident indicators change at about the same time as peaks and troughs. Industrial production, personal income less transfer payments are examples of coincident indicators.

The uses of economic indicators are that they give some criteria, based on which we can arrive at current and future growth patterns of the economy. Their limitation is the same too, in that they can at best indicate not tell for sure which way the economy will move.

Identifying past, current and future business cycle phase of an economy based on economic indicators

Leading, lagging and coincident indicators must be used in conjunction before the phase of the business cycle is identified and predictions made.

For example, in the US, the Leading Economic Indicator Index, comprised of a weighted average that indicates cyclical peaks and troughs, showed expansion of eight of the ten indicators. Leading the pack were interest rate spreads, credit availability, stock prices and new home permits. The coincident index rose by few percentage points and the lagging indicator index reduced by a few. Put together they all indicate a period of expansion of the US economy for that year.