Leading, coincident and lagging economic indicators

What are the three types of indicator?

Economic indicators are statistics that describe the state of an economy. Analysts and policy makers use them to see where the economy is in the cycle and to judge turning points. They are classified by when their own turning points occur.

• Leading economic indicators turn before the economy does and are used to forecast the near-term future.
• Coincident economic indicators turn at about the same time as the economy and show the present state.
• Lagging economic indicators turn after the economy and confirm what has already happened. They change only once a trend is established.

Economic indicatorsclassified by when their turning points occur relative to the economy

• Leading Memorize turn first; forecast the near-term future
  • Stock prices
  • Building permits; house prices
  • Average weekly hours, manufacturing
  • Initial claims for unemployment insurance
  • New orders: consumer goods; capital goods ex defense and aircraft
  • Yield spread: 10-year yield minus overnight rate
  • Consumer expectations; purchasing managers’ new orders; credit index
  • Retail sales
• Coincident Memorize turn with the economy; show the present
  • Industrial production
  • Real personal income
  • Manufacturing and trade sales
  • Employees on non-farm payrolls
• Lagging Memorize turn after; confirm what happened
  • Average duration of unemployment
  • Inventory–sales ratio
  • Change in unit labor costs
  • Inflation
  • Average prime lending rate
  • Consumer installment debt to income
  • Commercial and industrial loans outstanding

Leading (turn first)	Coincident (turn with)	Lagging (turn after)
Stock prices	Industrial production	Average duration of unemployment
Building permits for new housing; house prices	Real personal income	Inventory–sales ratio
Average weekly hours, manufacturing	Manufacturing and trade sales	Change in unit labor costs
Initial claims for unemployment insurance	Employees on non-farm payrolls	Inflation (services-heavy prices)
New orders: consumer goods; capital goods excluding defense and aircraft		Average prime lending rate
Yield spread (10-year yield minus overnight rate)		Consumer installment debt to income
Consumer expectations; purchasing managers’ new orders; credit conditions; retail sales		Commercial and industrial loans outstanding

A reason for each helps you rebuild the list:

• Weekly hours lead because firms change overtime before headcount.
• Initial claims are a sensitive test of early layoffs and rehiring.
• Building permits are needed before construction can start.
• New orders come before production, and consumer expectations come before spending.
• The yield spread signals expected short rates and activity: when it narrows or inverts (short rates above long rates), markets expect short rates and activity to fall.
• Unemployment duration lags because people stay unemployed longer even after hiring restarts.
• The inventory–sales ratio lags because stock piles up at the peak and is run down only when sales pick up.
• Unit labor costs, inflation, the prime rate and loans adjust slowly. Consumers borrow heavily only when confident, and the debt stays through a downturn.

Exam tip If you cannot recall a member, ask whether it is an early intention (leading), current output (coincident) or something that piles up or gets confirmed afterwards (lagging).

Go deeper Why the yield spread leads

Long-term yields embed the market’s expectation of future short-term rates. A wider spread anticipates rising short rates and so an economic upswing. A narrowing or inverted spread says short rates are expected to fall, which markets do when they foresee weaker activity. Because markets price this in advance, the spread turns before the economy.

Go deeper Indicators are empirical, and imperfect

Which indicators lead, coincide or lag is learned from history in each economy, so lead times vary and the lists differ by country. Euro-area composites include services expectations, while some others add business failures or labor-market series. Indicators also give false signals: a survey can tick up while GDP falls. Treat them as evidence, not proof.

How do you read a dashboard of indicators?

Work in three steps and never act on a single release.

1. Check the leading indicators for direction.
2. Check the coincident indicators for where the economy is now.
3. Use the lagging indicators to confirm.

What are composite and diffusion indexes?

Use it

A composite indicator combines several variables that tend to move together, usually up to a dozen handpicked series. Two well-known examples are a US leading index with ten components (built on the classical cycle) and the Organisation for Economic Co-operation and Development (OECD) composite leading indicators, built on the growth cycle and designed to compare countries. Survey indicators such as business and consumer confidence and purchasing managers’ indexes often feed these composites.

A diffusion index measures how widespread a move is across the components of a composite. Using the scoring of a well-known US index:

• component up by more than 0.05%: score 1
• component within ±0.05%: score 0.5
• component down by more than 0.05%: score 0

$$DI = \frac{U + 0.5F}{N} \times 100$$

Here $U$ is the number of rising components, $F$ the number of flat components and $N$ the total number of components.

Unlike a simple average, a diffusion index ignores outliers: one huge move adds no more than a small one. That makes it a good check on whether a change in a composite index is broad-based.

What are big data and nowcasting?

Know the idea

Modern composite indexes can use many series. The Chicago Fed National Activity Index, for example, uses 85 monthly series and a statistical technique called principal components analysis to extract the trend common to most of them. A euro-area counterpart uses more than 100.

Nowcasting estimates the current state of the economy in real time, before official figures arrive. It uses data as they are released, such as financial market transactions, internet searches and electronic payments, to estimate GDP growth, inflation or unemployment for the current period. A well-known public example is the Atlanta Fed’s GDPNow, a running estimate of current-quarter GDP growth that converges toward the official advance estimate as more data arrive.