What Is a Lagging Economic Indicator?
A lagging economic indicator is a measurable economic factor that changes only after a broader economic trend has already begun or been established. These indicators provide confirmation of past economic activity and are often used to analyze the severity and duration of economic cycles, rather than to predict future economic shifts. They are a crucial component within the broader field of economic indicators, which serve as statistical data points for evaluating the overall health and direction of an economy.
Unlike a leading economic indicator, which signals future changes, or a coincident economic indicator, which moves concurrently with the economy, a lagging economic indicator provides a retrospective view. For instance, the unemployment rate typically only falls significantly well after an economic expansion has taken hold, as businesses become confident enough to increase hiring. Similarly, corporate profits often decline after a recession has already begun.
History and Origin
The concept of classifying economic data into leading, coincident, and lagging categories gained prominence with the work of the National Bureau of Economic Research (NBER), particularly its Business Cycle Dating Committee. Since its establishment in 1938, the NBER has been responsible for maintaining the official chronology of U.S. business cycles, identifying periods of expansion and recession. The committee meticulously analyzes a wide array of economic data to determine the peaks and troughs of economic activity, often announcing these turning points with a significant delay, reflecting the nature of lagging indicators themselves. For example, the NBER concluded that the peak of economic activity before the short but sharp 2020 recession occurred in February 2020, but the committee waited until months later, in June 2020, to make this official announcement, illustrating the backward-looking nature of their assessment process which relies on lagging data.11, 12
The NBER's methodology for dating business cycles relies on various indicators, many of which inherently lag, such as the unemployment rate or certain income measures, to confirm the onset or end of an economic phase.9, 10 This approach underscores the value of lagging economic indicators in providing definitive confirmation, even if that confirmation arrives after the event has already transpired.
Key Takeaways
- Lagging economic indicators confirm a pattern or trend in the economy that has already occurred.
- They are useful for analyzing the duration and severity of economic phases like recessions or expansions.
- Common examples include the unemployment rate, corporate profits, and interest rates.
- These indicators are primarily used for historical analysis and validation rather than for forecasting.
- Policymakers often review lagging economic indicators to assess the effectiveness of past monetary policy or fiscal policy interventions.
Interpreting the Lagging Economic Indicator
Interpreting a lagging economic indicator involves understanding that its movement signifies the consolidation of a past economic trend. For instance, a persistent decline in the unemployment rate, which typically lags economic recovery, confirms that the labor market is indeed strengthening following an economic downturn. Similarly, a rise in the Consumer Price Index (CPI), a measure of inflation, usually occurs after a period of robust consumer spending and increasing aggregate demand have taken hold.
Analysts use these indicators to confirm whether a previously identified trend, perhaps initially signaled by leading or coincident indicators, has truly materialized and become entrenched. While they offer little foresight into immediate future conditions, their value lies in providing concrete evidence of the economy's historical performance, which is vital for long-term strategic planning and evaluating policy effectiveness. For example, a central bank might look at several quarters of declining Gross Domestic Product (GDP) figures, which are often revised, alongside the unemployment rate, to confirm that a recession has indeed occurred and to gauge its impact. The Federal Reserve specifically monitors GDP as an indicator of overall economic health.8
Hypothetical Example
Consider a hypothetical scenario where the economy has just emerged from a recession.
- Initial Signs: Leading indicators, such as consumer confidence and new building permits, began to show improvement six months ago, hinting at a potential recovery.
- Coincident Confirmation: Around three months ago, coincident indicators like retail sales and industrial production started to tick up, suggesting the recovery was underway.
- Lagging Confirmation: Now, after several months of improving economic activity, the national unemployment rate, a prominent lagging economic indicator, begins to consistently decline from its recessionary peak.
- Interpretation: This sustained drop in unemployment confirms that businesses are no longer just maintaining existing staff but are actively hiring, solidifying the view that the economic recovery is firmly established. The decreasing unemployment validates the earlier signals from leading and coincident indicators, providing concrete evidence of the past economic rebound.
Practical Applications
Lagging economic indicators are extensively used in various financial and economic contexts, primarily for confirmation and analysis:
- Monetary Policy Decisions: Central banks, such as the Federal Reserve, closely monitor lagging indicators like the unemployment rate and inflation to evaluate the impact of their past policy decisions. For instance, if inflation remains stubbornly high despite rate hikes, it might signal the need for further tightening. The Federal Open Market Committee (FOMC) regularly assesses economic data, including unemployment and inflation, to guide its monetary policy.6, 7
- Business Planning: Companies use these indicators to confirm market conditions for strategic planning, such as reviewing past sales data against economic cycles to forecast future trends or adjust capital investment plans.
- Investment Analysis: Investors and analysts use lagging indicators to confirm the presence of established trends, informing long-term asset allocation decisions or validating the overall health of specific sectors or the broader market. For example, a sustained increase in corporate profits, a lagging indicator, can confirm a robust earning environment for equity markets.
- Government Policy Evaluation: Governments review lagging indicators to assess the effectiveness of fiscal stimulus packages or other economic interventions, helping them understand if past policies achieved their desired outcomes, such as sustained economic growth or increased employment.
- Academic Research: Economists and researchers use historical data of lagging indicators to study business cycle dynamics, test economic theories, and refine econometric models for future analysis. The Federal Reserve Bank of St. Louis, through its FRED database, provides extensive historical economic data, including many lagging indicators, for public and academic use.5
Limitations and Criticisms
While valuable for confirmation, lagging economic indicators have inherent limitations:
- Delayed Signals: Their primary drawback is the delay in reflecting economic changes. By the time a lagging economic indicator signals a shift, the underlying economic event has already occurred, making them less useful for real-time decision-making or immediate forecasting. This "time gap" between economic activity and data reporting can complicate policy responses.4
- Data Revisions: Many economic indicators, including lagging ones, are subject to revisions. Initial estimates can be adjusted significantly as more comprehensive data becomes available, potentially altering the interpretation of past economic conditions.3 For example, GDP figures are frequently revised.
- Not Predictive: Relying solely on lagging indicators for future economic outlook can lead to misjudgments, as they offer no forward-looking insight. They confirm what has been, not what will be, a critical distinction in economic forecasting.
- Correlation vs. Causation: While lagging indicators correlate with economic cycles, their movement is a result, not a cause, of broader economic shifts. Mistaking correlation for causation can lead to flawed policy prescriptions or investment strategies.
- Incomplete Picture: No single indicator, including a lagging economic indicator, can capture the full complexity of an economy. Factors like quality of life, environmental impact, or underground economic activity are often not fully reflected in traditional measures like GDP or unemployment.1, 2
Lagging Economic Indicator vs. Leading Economic Indicator
The fundamental difference between a lagging economic indicator and a leading economic indicator lies in their timing relative to the overall business cycle.
Feature | Lagging Economic Indicator | Leading Economic Indicator |
---|---|---|
Definition | Changes after a trend has been established, confirming it. | Changes before a trend becomes prevalent, predicting it. |
Purpose | Confirmation, historical analysis, policy evaluation. | Prediction, early warning, strategic positioning. |
Timing | Moves after the economy. | Moves before the economy. |
Examples | Unemployment rate, corporate profits, average interest rates, CPI. | Stock market performance, building permits, consumer confidence, manufacturing new orders. |
Use Case | Understanding the depth/duration of past cycles. | Anticipating future economic shifts. |
Confusion often arises because both types of indicators are used to understand the economy. However, their applications are distinct. A leading indicator might suggest a recession is coming, while a lagging indicator, like a rising unemployment rate, confirms that a recession is already underway or has deepened. Investors and policymakers often consider a basket of both leading and lagging indicators, along with coincident economic indicators, to form a comprehensive view of the economy's current state, past trajectory, and likely future path.
FAQs
What are common examples of lagging economic indicators?
Common examples of a lagging economic indicator include the unemployment rate, corporate profits, average prime rate (a type of interest rate), Consumer Price Index (CPI), and labor costs. These indicators reflect changes only after economic shifts have already taken place.
Why is the unemployment rate considered a lagging economic indicator?
The unemployment rate is considered a lagging economic indicator because businesses typically wait to see a sustained improvement in economic conditions before they begin hiring new employees or rehiring laid-off workers. Conversely, during an economic downturn, companies may try to retain workers as long as possible before resorting to layoffs, causing unemployment to rise after the recession has already begun.
Are lagging indicators useful for economic forecasting?
No, lagging indicators are generally not useful for direct economic forecasting. Their primary utility lies in confirming economic trends that have already occurred and in providing a historical perspective on the duration and severity of economic cycles. For future predictions, leading economic indicators are more appropriate.
How do policymakers use lagging economic indicators?
Policymakers, such as central banks and government agencies, use lagging economic indicators to evaluate the effectiveness of past economic policies. For example, the Federal Reserve might observe a decline in the unemployment rate and a stabilization of price stability to assess if previous adjustments to the federal funds rate or other monetary tools have achieved their intended goals of maximum employment and stable prices.