What Is a Lagging Economic Index?
A lagging economic index is a composite measure whose movements tend to occur after changes in the overall business cycles of an economy. These indicators, part of the broader field of macroeconomics, confirm trends that have already taken place, rather than predicting future economic activity. While they do not offer foresight, lagging economic indexes are crucial for analyzing the severity and duration of economic shifts, such as a recession or an expansion. They provide retrospective insight, helping economists and policymakers understand the true state and trajectory of the economy.
History and Origin
The systematic classification of economic indicators into leading, coincident, and lagging categories gained prominence through the work of the National Bureau of Economic Research (NBER). Founded in 1920, the NBER became the quasi-official arbiter of U.S. business cycle dates, publishing its first business cycle dates in 1929. The NBER's Business Cycle Dating Committee, established in 1978, relies on a range of economic measures to determine the peaks and troughs of economic activity, often announcing these dates months after they have occurred, underscoring the lagging nature of much economic data15, 16. This methodology acknowledges that certain economic data points, such as the unemployment rate or corporate profits, only visibly shift well after the underlying economic turning point.
Key Takeaways
- A lagging economic index confirms past economic trends rather than predicting future ones.
- Common examples include the unemployment rate, corporate profits, and the Consumer Price Index.
- These indicators are vital for retrospective analysis, helping to assess the depth and duration of economic events.
- Policymakers use lagging economic indexes to evaluate the effectiveness of past monetary policy and fiscal policy decisions.
- Due to their backward-looking nature, they are less useful for real-time decision-making but offer valuable historical context.
Interpreting the Lagging Economic Index
Interpreting a lagging economic index involves understanding that its movements validate patterns already observed or initiated by other indicators. For instance, the unemployment rate is a classic lagging indicator. When an economy enters a recession, businesses may first reduce hiring or cut hours before outright laying off workers. It takes time for these initial slowdowns to translate into a measurable increase in the unemployment rate. Conversely, after an economic recovery begins, businesses typically increase existing workers' hours or rehire laid-off staff before significantly expanding their workforce, causing the unemployment rate to decline only after the expansion is well underway13, 14. Thus, a rising unemployment rate confirms a downturn, while a falling rate confirms a recovery.
Other lagging indicators, such as corporate profits, typically show a decline after a recession has begun and only improve once economic activity has picked up. Similarly, the average duration of unemployment tends to increase during and after a recession, reflecting the difficulty of finding new employment, and decreases only once the labor market strengthens significantly11, 12.
Hypothetical Example
Consider a hypothetical scenario where an economy experiences a sudden shock, such as a sharp rise in energy prices or a significant drop in consumer confidence. Initially, leading economic indicators would signal a potential downturn. However, a lagging economic index would not immediately reflect this.
Suppose the economy begins to slow down in January. By March, Gross Domestic Product (GDP) figures for the first quarter, which are coincident indicators, might show a modest decline. However, the unemployment rate, a lagging indicator, may not show a significant increase until several months later, perhaps in June or July. This delay occurs because businesses often try to absorb initial downturns through reduced hours or hiring freezes before resorting to widespread layoffs.
If the economy officially entered a recession in January, as determined retrospectively by authorities like the NBER10, the unemployment rate would only rise noticeably after that point, confirming the recession's impact on the labor market. It might continue to rise even as other forward-looking indicators suggest a recovery is on the horizon, only peaking and beginning to decline well into the subsequent economic expansion.
Practical Applications
Lagging economic indexes are widely used in various financial and economic analyses, despite their backward-looking nature. Governments and central banks, such as the Federal Reserve, utilize these indicators to assess the impact of their past monetary policy decisions and validate the severity and duration of economic cycles. For example, the Bureau of Labor Statistics (BLS) regularly publishes the U.S. unemployment rate, which is a key lagging indicator closely monitored by policymakers and the public to gauge the health of the labor market8, 9. Similarly, the U.S. Bureau of Economic Analysis (BEA) releases data on Gross Domestic Product (GDP), providing comprehensive insights into past economic performance6, 7.
In investment analysis, while not predictive, lagging indicators help confirm trends before making long-term investment or asset allocation decisions. For instance, an investor might wait for corporate profits to show sustained improvement before fully committing to a cyclical industry, confirming that the economic recovery is firm. Economists also use a lagging economic index to refine their economic forecasting models by providing historical data points against which predictions can be calibrated.
Limitations and Criticisms
The primary limitation of a lagging economic index is its retrospective nature. By definition, these indicators provide confirmation of economic trends only after they have occurred, making them less useful for real-time decision-making or anticipating future market movements. This delay can lead to challenges for policymakers who need to implement timely interventions5. For instance, by the time the unemployment rate significantly rises, a recession may already be deeply entrenched, and the effects of a potential fiscal policy response would not be immediately apparent.
Furthermore, the data for many lagging indicators are subject to revisions, which can alter the initial interpretation of economic conditions4. The Bureau of Economic Analysis, for example, often revises its GDP estimates as more complete data become available3. Such revisions can sometimes paint a different picture of past economic health than what was initially reported, complicating the analysis. Critics also point out that relying solely on conventional macroeconomic indicators may not fully capture the quality of life or broader societal well-being, as they often focus narrowly on monetary measures1, 2.
Lagging Economic Index vs. Leading Economic Index
The fundamental distinction between a lagging economic index and a leading economic index lies in their timing relative to the overall business cycles. A leading economic index is designed to predict future economic activity, with its components typically moving before a change in the broader economy. Examples include building permits, consumer expectations, and manufacturers' new orders for capital goods. These indicators offer foresight, helping forecasters anticipate turns in the economy.
In contrast, a lagging economic index confirms trends that have already taken place, moving after the general economy has shifted. Key examples include the unemployment rate, average duration of unemployment, the Consumer Price Index (representing inflation), and corporate profits. While leading indicators are forward-looking and used for prediction, lagging indicators are backward-looking and used for confirmation and assessing the depth of economic changes. Both types of indicators, along with coincident economic indicators (which move concurrently with the economy), are essential for a comprehensive understanding of economic performance.
FAQs
What are some common examples of a lagging economic index?
Common examples of components within a lagging economic index include the unemployment rate, corporate profits, the average duration of unemployment, the Consumer Price Index (a measure of inflation), and the average prime rate charged by banks for short-term commercial loans.
Why is a lagging economic index important if it doesn't predict the future?
While a lagging economic index doesn't predict the future, it is crucial for confirming past economic trends and evaluating the severity and duration of economic events like recessions or expansions. This retrospective analysis helps validate the actual impact of economic shifts on various sectors and provides context for assessing the effectiveness of economic policies.
How do policymakers use a lagging economic index?
Policymakers use a lagging economic index to assess the effectiveness of their past monetary policy and fiscal policy decisions. For instance, a persistent decline in the unemployment rate after policy interventions would confirm that those measures contributed to labor market recovery.
Can a lagging economic index be revised?
Yes, data for many lagging economic indicators, such as Gross Domestic Product and corporate profits, are often subject to revisions as more complete information becomes available. These revisions can sometimes change the initial assessment of past economic conditions.
Is the stock market a lagging or leading indicator?
The stock market is generally considered a leading economic indicator because stock prices often reflect investors' expectations about future corporate earnings and economic conditions. Movements in the stock market typically anticipate broader economic shifts.