Where is the Economy Headed? These Indicators Might Give You a Clue

Are you ready for another recession? There is a good chance that another one is coming. Paul Krugman, winner of a Nobel Prize in economics, now thinks that there is a 50% chance that a global recession is on its way. While Krugman thinks that there is a chance that Obama’s jobs plan could make a difference, and help reduce likelihood of a double dip recession, he expects Republicans in Congress to block passage, and he expects that problems in the euro zone are still likely to impact the global economy.

Of course, you don’t have to rely on pundits, economists and politicians to tell you what might happen with the economy (what actually ends up happening is something that few can truly predict with complete accuracy). You can actually read the signs yourself. Get acquainted with economic indicators, and you could very well get an advance warning for what’s about to happen in time to make changes to your personal finances and prepare for the next recession.

Leading Economic Indicators

If you want a clue about what could be coming in terms of economic recovery or recession (or even depression), you can pay attention to leading indicators. While these indicators aren’t full proof, they do provide an indication that all may not be well – even though the lay offs may not have started yet:

• Housing Market: Prior to the Great Depression, there was an explosion in building activity and the number of homes built sky-rocketed. However, the demand just wasn’t there, and prices began dropping. Sound familiar? When the supply of homes exceeds demand, it can be indication of trouble on the way. When housing prices show an increase, it can indicate that recovery is on the way.
• Manufacturing Activity: Even though our economy has been moving away from a manufacturing base, and toward a more service oriented economy, manufacturing activity can still be a leading indicator of where the economy is headed. When manufacturing activity increases, it can be a sign that more people are interested in consumer goods. The manufacture of goods to meet demand means that people are buying (which accounts for about 2/3 of economic activity in the U.S.).
• Inventory Levels: Another leading indicator of what’s next could be inventory levels. High inventory sometimes means that consumer demand is expected to rise – and sometimes it means that there isn’t the demand to justify the supply. If various inventory levels rise too quickly, and deplete to slowly, it might mean that the economy is headed down, since people aren’t buying.
• Retail Sales: Strong retail sales numbers are often considered indications that the economy is ready to recover. It means that people are spending money on goods, and that the good result should be reflected in GDP and the economy overall. However, it is important to be careful when considering this indicator; if debt is rising too quickly along with retail sales, it means that perhaps consumers can’t really afford all these purchases because they are using credit. Once the credit-go-round becomes overburdened, everything comes to a grinding halt.

Often, when considering these leading economic indicators, it helps to consider them together, rather than separately. It might seem good that inventory levels are high, but high inventory levels, combined with low manufacturing activity and low retails sales means that trouble is on the way – consumers aren’t actually buying enough to clear the backlog of inventory. Likewise, you can look at housing market data in concert with building permits and lending activity. If more loans are being approved, and building permits are increasing, the economy could be headed for improvement, since the demand for homes is likely to keep pace with supply.

Another consideration might be the stock market. Many consider the stock market an economic indicator, since it reflects general sentiment (perception has a way of being a big influence on economies), and it can serve as an illustration of how profitable companies expect to be in the future. However, it is important not to get too hung up on the stock market as an economic indicator – and important not to get too hung up on considering the Dow Jones Industrial Average to be “the stock market.”

Lagging Economic Indicators

You probably noticed that there are some economic indicators missing. What about employment? Income/wages? Inflation? All of these things are economic indicators, but they are considered lagging indicators. Rather than providing a potential peek at where the economy might be going, lagging economic indicators provide a picture of where the economy has been, allowing you to pick out overall trends:

• Employment: Many people are focusing on the employment rate right now. However, the employment rate doesn’t show where the economy is going. Rather, it is an indication that the economy has been poor enough that people are being laid off. The official unemployment rate for August 2011 is 9.1%. However, some argue that the real unemployment rate is higher if you take into account people who have given up looking for jobs, and those who have to work part-time – even though they would like a full time job. However, even though the jobs market is considered a lagging indicator, it can influence sentiment, and encourage consumers to tighten the purse strings, contributing to a further slow down in economic activity.
• Income and Wages: When employers cut their workforces, or reduce the hours employees work, it begins to affect household income and wages. These numbers can’t be seen until after the fact, lagging behind what’s happening in the economy. Looking back, though, it is usually possible to trace a trend line in income and wages to what has been happening with the economy.
• Inflation: When the CPI drops, it is considered a sign that the economy is showing signs of slowing. However, changes to inflation often don’t manifest until after the economy has already begun to recess or recover.

Of course, there are more indicators related to the economy. Policy makers use economic indicators – both leading and lagging – to make decisions about how to tinker with the economy to try and produce the desired level of economic growth. When indicators show that the economy could be headed for recession (or already in recession), policy makers try to boost economic activity. When things are getting to heated in the economy, they try to implement measures to keep inflation under control.

Do you think efforts to read the economy are successful? Do efforts to control the economy ultimate help or hinder the situation?