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It would be nice if an economy could grow all the time at a single constant rate, unfortunately that is not how it happens.  Economies grow in booms (periods of high economic growth) and busts (periods of economic decline).  Such activity gives economic growth a wavy appearance in which the wave is slowing climbing as is demonstrated in the graph below.

The area of the graph designated as A shows a recessionary period the economy is getting smaller.  The area designated as B shows a growth period, the economy is getting larger.  A closer look at the graph indicates that this economy is growing over time, the end of left side of the graph is lower than the right side.

Because of this continual riding of the waves it would be nice if we knew where we were on the wave. Are we going into a period of growth or a period of recession or are we going to continue riding the waves in the same place?  Economic indicators try to answer these questions.  There are three types of indicators; leading, coincidental and lagging.  Each of these three types together gives a good picture of where we are.

Leading Index Components
 

1. Average weekly hours in manufacturing
2. Average weekly initial claims for unemployment insurance
3. Manufacturers new orders, consumer goods and materials, adjusted for inflation
4. Vendor performance, percent of index measuring firms receiving slower deliveries
5. Contracts and orders for plant and equipment, adjusted for inflation
6. Index of new private housing units authorized by local building permits
7. Change in manufacturers unfilled orders for durable goods, adjusted for inflation
8. Percent change in sensitive material prices, smoothed
9. Money Supply, M2, adjusted for inflation
10. Index of consumers expectations

Coincidental Index Components
 

1. Employees on non-agricultural payrolls
2. Personal income less transfer payments, adjusted for inflation
3. Index of industrial production
4. Manufacturing and trade sells adjusted for inflation

Lagging Index Components
 

1. Average duration of unemployment in weeks
2. Ratio of manufacturing and trade inventories to sales, adjusted for inflation
3. Percent change in manufacturing labor cost per unit output, smoothed
4. Average prime rate charged by banks
5. Commercial and industrial loans outstanding, adjusted for inflation
6. Ratio of consumer installment credit outstanding to personal income
7. Percent change in the consumer price index for services, smoothed

Before a recession, stock prices and the real money supply almost always decline.  New orders, new businesses being formed and housing starts (permits) decrease. This indicates that there is a decrease in aggregate demand.  Businesses begin to cut back on the number of people employed and the number of hours which they work, this leads to a fall in income, indicating that aggregate demand will fall.  Other indicators that a recession is about to begin are a wider difference between the interest rate on commercial paper and treasury bills and an inverted yield curve.

During a recession, firms cut back on the number of people employed, both production and sales fall.

After a recession, unemployment usually peaks after output has fallen to its lowest level. The other indicators fall after a recession has ended.  Interest rates also hit bottom after the recession has ended.

One popular rule of thumb on economic indicators is the direction of the economy will turn (enter a recession or expansion) when the majority of leading economic indicators change direction for two months in a row.  For example if the majority indicators declined over the previous two months this is an indication that the economy has begin to slow down perhaps entering a period of recession.

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