Economists love to think they can predict the future. They can't, but they can get a pretty good idea of what is likely to happen by analyzing certain statistics. Since these provide an indication of what is happening in the economy, they are referred to as economic indicators.
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- GDP: Gross Domestic Product is considered the most important measure of how the economy is doing. It measures the dollar value of everything produced in the United States -- both goods (tangible objects, like cowboy boots) and services (things people do for us, like cut our hair). The GDP figure is publicized every three months, and an annualized figure is released each year. Economists look at the rate at which GDP grows on top of inflation. They like to see a real growth rate of between 2.5 percent and 3 percent, because historically this has been a sustainable rate. Any higher, and the Fed might worry about inflation if the economy grows too fast and shortages may arise in the economy thus raising prices. The Fed in that case can possibly raise interest rates to slow the economy down. Any lower, and the Fed might try to give the economy a kick by lowering interest rates.
- Consumer Price Index (CPI): This shows whether prices of common consumer items are rising or falling, and is considered the most important indicator of inflation. The CPI compares prices of a set list of goods to prices for the same goods in a base period. It looks at imports as well as domestic items, including housing, food, fuel, clothing, transportation and medical care, among others. A larger than expected rise could be considered inflationary, leading to higher interest rates.
- Index of Leading Economic Indicators: This index measures the growth (or lack thereof) of 10 representative sectors of the U.S. economy. These sectors are called "leading" not because they are superior to others, but because they provide a good sense of where the economy is headed. (Indicators that show where the economy is are referred to as coincident economic indicators, and those that respond to the business cycle with a delay, i.e., show where the economy has been are called lagging economic indicators.) As a general rule, if this index changes direction and remains consistent for three months in a row, the overall economy may be headed that way. For example, if the index has been steadily increasing for a while, then decreases or remains stagnant for three months in a row, the economy could be headed for a slowdown. The release of this particular index doesn't usually cause much fuss in itself, because many of the components have already been released earlier. Sectors measured include employment, factory orders, the S&P 500 performance, the money supply, and the spread between the 10-year bond and the Fed Funds rate.
- Unemployment: The unemployment rate is a lagging indicator, meaning it is really a better indication of where the economy has been than where it is going. A consistently low unemployment rate is often taken as a sign that inflation could be around the corner. (Too many people have too much money to spend, driving prices up.) The "natural rate" of unemployment -- i.e., one that will not provoke inflationary tendencies -- is generally thought to be around 5.5 percent. Therefore, repeated reports that unemployment is below that level would fuel fears of inflation to come.
- Housing starts: The housing sector is generally the first to slide when the economy is getting ready for a downturn (and the first to pick up before a boom). Whether people will build and buy houses tells a lot about general confidence in the economy. That's why economists pay close attention to trends in housing starts -- the annual rate of groundbreaking for new privately owned housing units. This figure is released monthly.
