What Is Lagging Indicators?
Lagging indicators are economic or financial metrics that change after a broader economic trend or significant event has already occurred. In the realm of macroeconomics, they are crucial for confirming patterns and understanding the severity or duration of economic shifts, rather than predicting them. Unlike leading indicators, which attempt to forecast future economic activity, lagging indicators provide a retrospective view, confirming what has already transpired. This characteristic makes them invaluable for historical analysis, policy evaluation, and solidifying the assessment of a given economic phase, such as a recession or expansion.
History and Origin
The concept of economic indicators, including those that lag, has evolved significantly over time, becoming central to the field of econometrics. Early economic analysis focused on understanding business cycles. Institutions like the National Bureau of Economic Research (NBER), founded in 1920, began systematically collecting and analyzing economic data to identify and date periods of economic expansion and contraction. The NBER's Business Cycle Dating Committee, established in 1978, plays a critical role in formally identifying peaks and troughs in U.S. economic activity, often relying on various economic indicators, some of which are lagging, to confirm these turning points. Their meticulous approach provides an official chronology of U.S. business cycles, which serves as a foundational reference for economists and policymakers.8, 9, 10
Key Takeaways
- Lagging indicators confirm established economic trends or events.
- They are best used for historical analysis and confirming the end or beginning of economic cycles.
- Common examples include the unemployment rate, corporate profits, and interest rates.
- Lagging indicators provide a fuller picture of past economic performance but offer limited predictive power.
- They are distinct from leading and coincident indicators.
Interpreting the Lagging Indicators
Interpreting lagging indicators involves analyzing their behavior relative to known economic shifts. Because these indicators confirm trends that have already taken hold, their movement provides validation and insight into the depth and duration of an economic period. For instance, a declining unemployment rate typically confirms that an economic recovery is well underway, as businesses often wait for sustained demand before hiring aggressively. Similarly, a rise in corporate profits confirms robust economic growth that has already stimulated demand and reduced costs. Policymakers and analysts use these confirmed trends to evaluate the effectiveness of past monetary policy or fiscal policy decisions. The Federal Reserve Bank of St. Louis, for example, provides extensive data on various economic indicators, including those that are lagging, which can be used to analyze business cycle patterns.5, 6, 7
Hypothetical Example
Consider a hypothetical scenario involving a significant economic downturn. Initially, leading indicators might have signaled a potential slowdown. As the downturn progresses, coincident indicators would reflect the real-time contraction. However, it is the lagging indicators that would confirm the severity and eventual end of the recession. For example, the unemployment rate might continue to rise even as the economy begins to stabilize or show early signs of recovery. If the unemployment rate eventually peaks and then consistently declines over several months, it would serve as a lagging confirmation that the recession has likely ended and an economic expansion is in progress. This lag highlights why these indicators are more useful for confirming existing trends rather than predicting them.
Practical Applications
Lagging indicators are widely used in various practical applications within finance and economics:
- Business Cycle Confirmation: The National Bureau of Economic Research (NBER) uses a range of economic indicators, including several that are lagging, to formally declare the start and end dates of U.S. recessions. For example, Gross Domestic Product (GDP) and the unemployment rate are key components in their assessment.2, 3, 4
- Policy Evaluation: Governments and central banks often evaluate the impact of their economic policies based on the movement of lagging indicators. A sustained decline in the unemployment rate after a period of fiscal stimulus, for example, could indicate the policy's effectiveness.
- Investment Strategy: While not predictive for market timing, investors use lagging indicators to confirm the broader economic environment, which can influence longer-term asset allocation decisions. For instance, strong and sustained corporate earnings, a lagging indicator, typically underpin stock market performance.
- Credit Analysis: Lenders often look at lagging indicators such as default rates or consumer delinquencies to assess the overall health of the credit market and adjust their lending standards accordingly. Data from the Federal Reserve Bank of St. Louis indicates rising consumer delinquencies, suggesting a potential tightening of credit conditions.1
Limitations and Criticisms
The primary limitation of lagging indicators is their inherent backward-looking nature. By definition, they do not provide foresight into future economic conditions, making them unsuitable for proactive decision-making or short-term market timing. This delay can be problematic in fast-moving markets or during rapid economic shifts. For instance, waiting for the unemployment rate to confirm a recession means that businesses and individuals may have already experienced significant financial hardship.
Furthermore, relying solely on lagging indicators can lead to delayed policy responses, potentially exacerbating economic downturns or contributing to overheating during expansions. While the Federal Reserve and other central banks consider lagging data, their forward-looking monetary policy decisions often incorporate leading and coincident indicators to anticipate changes. Critics also point out that revisions to historical data for lagging indicators, such as GDP or corporate earnings, can alter the interpretation of past economic events, making real-time analysis challenging.
Lagging Indicators vs. Leading Indicators
The key distinction between lagging indicators and leading indicators lies in their timing relative to the broader economic cycle. Lagging indicators change after the economy has already shifted, confirming existing trends. Examples include the unemployment rate, corporate profits, and interest rates. Their value lies in confirming the duration and magnitude of economic phases.
In contrast, leading indicators attempt to predict future economic movements. They typically change before the overall economy begins to follow a particular trend. Examples include consumer confidence, manufacturing new orders, and housing starts. While leading indicators offer predictive power, they are often subject to false signals or revisions. Investors and analysts often use both types of indicators in conjunction for a more comprehensive understanding of economic conditions, with leading indicators providing foresight and lagging indicators offering confirmation and historical context. This combined approach is a cornerstone of technical analysis.
FAQs
What are some common examples of lagging indicators?
Common examples of lagging indicators include the unemployment rate, corporate profits, interest rates (especially the prime rate), consumer price index (CPI), and the duration of unemployment. These metrics only reflect changes after economic shifts have already taken place.
Why are lagging indicators important if they don't predict the future?
Lagging indicators are important because they provide confirmation and validate the existence and extent of economic trends. They are essential for historical analysis, assessing the impact of economic policies, and understanding the full scope of a business cycle.
How do lagging indicators differ from coincident indicators?
Lagging indicators confirm trends after they have occurred. Coincident indicators, on the other hand, move concurrently with the economic cycle, providing a real-time snapshot of the current economic state. Examples of coincident indicators include industrial production and personal income.
Can lagging indicators be used for investment decisions?
While not suitable for short-term market timing, lagging indicators can inform long-term investment strategies by confirming the underlying economic health. For example, sustained growth in corporate profits (a lagging indicator) can support a positive outlook for equity markets.
Who uses lagging indicators?
Economists, policymakers, central banks, and financial analysts all use lagging indicators. Institutions like the NBER rely on them to officially date business cycles. Portfolio managers and risk managers also incorporate them into their broader analyses to understand the economic environment.