What are Lagging Indicators?
Lagging indicators refer to a series of economic activities, events or developments that have already been taken place in the past and it helps in the identification of long term trends or economic patterns. Lagging indicators do not predict the future as the lagging indicators shifts only upon the occurrence of major economic events.
Economics Indicators are statistics about economic activities that are used to interpret economic data and predict future economic and financial trends. Indicators are broadly classified into three categories:
Top Lagging Indicators
#1 – Gross Domestic Products (GDP)
Gross domestic product is the total monetary value of all the finished goods and services produced within a country in a specific time period. GDP data is presented on a quarterly basis as an annual percentage and reflects the economic health of the country.
As GDP increases the economy gets strong
- Based on GDP growth, businesses adjust their inventory expenditures, asset investments, and credit policies.
- Investors can manipulate their asset allocation decision based on GDP performances. While investing in foreign countries they can compare the GDP growth rates of different countries before making decisions about allocating their assets and invests in fast-growing economies.
- The Federal Reserve uses GDP data while formulating its monetary policies.
- The governments can identify whether the nation’s economy is boosting or going towards recession E.g. The United States went through its longest economic recession between December 2007 and June 2009. A simple thumb rule says that when GDP drops for two or more quarters consecutively than a recession is at the nation’s doors.
#2 – Unemployment Rate
It measures the labor force of a nation without work or jobs. In other words, the people in a country who are not working as a percentage of the total labor force. When GDP is in poor shape or shows signs of recessions, employment opportunities become negligible and unemployment rates tend to increase aggressively.
In the U.S., the U3 or U-3 rate is presented as a monthly employment situation report.
Due to unemployment earnings reduces which reduces consumption; hence production decreases and results in overall poor economic health or lower GDP. Poor GDP also burdens the government with debts due to high spending on programs like unemployment benefits.
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#3 – Consumer Price Index (CPI)
CPI is a frequently used measure to quantify periods of inflation or deflation. It calculates the change in the cost of essential goods and services over time.
Inflation helps in quantifying the price levels in the economy and measure the purchasing power of a unit of currency of a country. During periods of high inflation, the value of a dollar may erode quickly as compared to the rise in earnings of a common citizen, thus purchasing power decreases and results in poor standards of living. However average inflation is not bad for the economy in-fact indicates positive sentiments.
#4 – Currency Strength
Currency is a commodity in itself. Currency strength expresses the value of a currency and often calculated as purchasing power by economists. A strong currency helps in increasing the nation’s purchasing as well as selling powers with other countries.
A nation like the USA with stronger currency can import products at cheaper rates and export at higher prices. However, there are disadvantages of having strong currency like dollar as well because goods of the US are highly-priced thus importing countries tries to find substitutes.
#5 – Interest Rates
The Interest rate is an important metric that affects every individual directly or indirectly. Directly if the person is an investor or a borrower and indirectly as interest rates influence the movement of the overall economy.
The interest rate refers to the cost of borrowing money related to the federal bank of a country. The Federal Bank under its monetary policies releases and collects funds from various nationalized banks at a fixed rate. In the USA this rate is determined by the Federal Open Market Committee (FOMC).
#6 – Corporate Earnings
It indicates the economic health of the business entities of a nation. Sound economic health is directly related to rising GDP due to increased production, better employment opportunities, improved stock market performances, etc.
For example, After-tax reforms in the US, the companies of the S&P 500 during the first quarter of 2018 showed a YOY EPS growth of around 26% which was the highest after 2010. Tax reforms increased the corporate earnings and had parallel positive impacts on economic growth as well; the US GDP growth was 4.1% per annum during the same period.
#7 – Trade Balance
The Balance of trades (BOT) is the difference between the value of a nation’s imports and exports for a given period. It is popularly used by economists to measure a country’s economic strength. There are two terms that prevailed under BOT viz. Trade Surplus and Trade Deficit.
A county that imports more than it exports has a trade deficit. Conversely, the generally desirable trade surplus is defined as more exports than imports in value terms. Trade deficits may result in devalued the nation’s currency and significant domestic debts.
The overall economic health of a country is dependent on various factors including consumer sentiments, governmental policies, domestic industrial performances, and the world market. The major role of economists is to compile these factors and create algorithms to predict where the economy is heading. But algorithms are never perfect and accurate prediction is nearly impossible. Since the economic gurus, many times fail to generalize the true economic trends, one must develop its own understanding of basic economic concepts. Knowledge of economic indicators helps in getting an idea about the direction of the economy so you can go with the flow.
This has been a guide to Lagging indicators. Here we discuss Top 7 Major Lagging indicators like GDP, Unemployment Rate, Interest Rate, and Currency Strength, etc. You can learn more about accounting from the following articles –