I reckon many must be confused about the current economic situation. We hear constant talk about how high interest rates and cost of living pressures are causing economic pain for many households, consumer confidence is at recessionary levels and various companies are expressing concern about the economic outlook. But at the same time the unemployment rate remains very low, lots of Australians seem to be holidaying in Europe and restaurants and cafes are doing well. While perplexing, it’s not that unusual at turning points in the economy for various indicators to be conflicting. Much of it comes down to the difference between leading, coincident and lagging economic indicators. This note looks at the differences and why it’s important to allow for them.

Leading versus lagging economic indicators…

Economic indicators can be divided based on whether they lead, lag or are coincident with the economic cycle measured by GDP growth. It’s important to be mindful of this when the economy is turning down. The next table lists examples of the most common indicators in each:

• Leading economic indicators are economic indicators which lead the economic cycle often by 6-18 months. This is because they reflect changes in monetary policy – like the yield curve which is the gap between long term bond yields and short-term interest rates which are a guide to whether monetary policy is tight or loose and money supply growth - or they respond quickly to changes in interest rates – like share markets, confidence and building approvals.

• Coincident indicators move with the economic cycle, so GDP growth by definition is coincident as are retail sales and household income.

• Lagging indicators tend to turn after the economic cycle has turned. Unemployment and inflation are lagging indicators because companies are invariably slow to adjust hiring and pricing decisions. They persist with decisions to hire or raise prices after demand has slowed because it takes a while to recognise that any downturn is permanent and turnaround the mechanisms by which they hire and raise prices.

  Of course, leads and lags for various indicators may vary for each cycle so it’s often best to focus on an average of them. Read full article