Economics I

Reading 15. Understanding Business Cycles

Learning Outcome Statements

i. interpret a set of economic indicators and describe their uses and limitations.

CFA Curriculum, 2020, Volume 2

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Subject 5. Economic Indicators

Economic indicators are statistics on macroeconomic variables that help in understanding which stage of the business cycle an economy is in. Economic indicators can be leading, lagging, or coincident, which indicates the timing of their changes relative to how the economy as a whole changes.

  • Leading: Leading economic indicators are indicators which change before the economy changes. Stock market returns are a leading indicator, as the stock market usually begins to decline before the economy declines and improves before the economy begins to pull out of a recession. Leading economic indicators are the most important type for investors as they help predict what the economy will be like in the future.

  • Lagging: A lagging economic indicator is one that does not change direction until a few quarters after the economy does. The unemployment rate is a lagging economic indicator as unemployment tends to increase for 2 or 3 quarters after the economy starts to improve.

  • Coincident: A coincident economic indicator is one that simply moves at the same time the economy does. The Gross Domestic Product is a coincident indicator.

No single indicator is able to forecast accurately the future direction of the economy. In the U.S., economists often refer to the Conference Board's diffusion index when judging the moves in the leading index. The diffusion index can measure the breadth of a move in any BCI index, showing how many of an index's components are moving together with the overall index. The index generally turns down prior to a recession and turn up before the beginning of a business expansion.

However, there are two problems with the index.

  • There has been significant variability in the lead time of the index. For example, a downturn in the index is not always an accurate indicator of the future.
  • The index has often given false alarms. For example, a recession forecasted by a decline in the index does not materialize.

While we cannot predict the future perfectly, economic indicators help us understand where we are and where we are going.

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User Contributed Comments 2

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the explanation of a diffusion index could be clearer here..