3 Types of Economic Indicators Explained

3 Types of Economic Indicators Explained

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While several economic indicators deserve a spot in this article, economists often employ three prominent macroeconomic measures to assess a country’s economic condition (state of the economy): the GDP (Gross Domestic Product), a measure of the economic activity of a country, inflation (CPI [consumer price index] and PPI [producer price index]) which measures price levels, and employment data to determine employment and unemployment within an economy.

As the US remains the largest economy in the world (according to GDP) and has done since the late 19^th century, this article will focus on the US.

Gross Domestic Product

GDP, or Gross Domestic Product, is one of the most important economic indicators used by economists, investors, traders, and just about anyone interested in a country's economic development.

Recognised as a lagging indicator, the GDP is defined as the total dollar market value of all goods and services produced within a given period within the borders of a country, hence the term Domestic. Although GDP is measured every quarter (every three months) by the Bureau of Economic Analysis, the BEA produces three estimates, released a month apart (Advance, Preliminary and Final). The Advance release tends to garner the most attention. Although an initial estimate (thus not complete), this is the most up-to-date news on growth and, therefore, can increase volatility in the financial markets.

Gross Domestic Product (Second Estimate [Preliminary]):

Three primary ways GDP is measured are the output method, the income method and the expenditure method. While it’s beyond the scope of this article to go into detail about each, each calculation should deliver a similar result (though there will be some inconsistencies). The BEA uses all three approaches to calculate GDP because each approach has its own strengths and weaknesses.

While GDP is an imperfect measure, when GDP is increasing, it generally means the economy is operating well, and vice versa for a falling GDP. Should two negative consecutive quarterly GDP numbers occur, this is referred to as a technical recession.

Nominal or Real GDP?

It is important to understand that GDP can rise on the back of two things: a rise in prices or a rise in productivity. If measuring economic performance using current prices—nominal GDP—we simply multiply the price by quantity using current prices (today’s prices). But, to find the real economic output of an economy, economists assess real dollars or base-year dollars. That is, economists employ a base-year price, thus deriving a value unaffected by price change (adjusted for inflation).

For example, imagine that we wanted to compute the real GDP for pears and bananas using 2015 dollars. This involves multiplying the price of pears and bananas in 2015 by the quantity produced today in 2023. So, with prices held constant, real GDP increases only if the economic output increases.

Ultimately, GDP provides a dollar value, a single number, that shows the dollar value of economic performance in a given time period.

Inflation

Released by the Bureau of Labour Statistics (BLS), a common indicator used to measure inflation (or the cost of living) is the consumer price index, or CPI. Another widely watched indicator is the producer price index, or PPI; this measures the price of a typical basket of goods and services on the wholesale side (firms) rather than consumers.

Inflation Defined:

Inflation is often confused. Inflation—another lagging indicator—is the (weighted) average price rise of goods and services over a specified period of time. Weights are applied to the index to reflect the relative importance of goods and services consumed by the average household. Deflation, on the other hand, represents a decline in prices, and disinflation is a slower increase in inflation: consumer prices (assuming we’re talking about CPI) are rising but rising at a slower rate than, say, one year ago.

An example of a disinflationary phase would be what we’re seeing in the US right now. Inflation was at 9.1% in June 2022, but in June of 2023, the inflation rate is 4.0%. So, inflation is rising compared to the year prior, but at a slower pace.

Inflation can be particularly detrimental to an economy, reducing the purchasing power of a country’s citizens. Inflation can also erode the value of savings and make it difficult for businesses to plan. When inflation increases beyond a central bank’s inflation target (generally around 2-3%), that country’s central bank will usually embark on policy firming: increase the benchmark interest rate to attempt to restrain consumption, similar to what we saw in 2022 and still now in 2023 in many countries. This will usually cause increased demand for that nation’s currency as investors seek higher yields.

Headline and Core Inflation?

You’ll often hear market commentators refer to headline and core inflation data.

Headline inflation, referred to as ‘All items’ by the BLS, represents the raw value of inflation which includes all of the items in the basket of goods and services. Core inflation data, on the other hand, strips out volatile components, such as energy and food. You’ll find the core inflation data under ‘All items less food and energy’ in the monthly BLS release.

Central bank policymakers widely watch core inflation as a gauge for long-term inflation.

Unemployment Rate

The employment situation report is an important monthly economic release, calculated from a sample of around 60,000 households called the Current Population Survey (CPS).

Even if you are a steadfast technical analyst, vowing never to include any type of economic data in your analysis, you will likely be aware of the US employment situation report released on the first Friday of every month by the Bureau of Labour Statistics (BLS).

The unemployment rate is derived from the Household Survey in the BLS release. Functioning as a lagging indicator, the unemployment rate is calculated by dividing the number of unemployed (technically, these are US citizens that are 16 years old and over who are willing and able to work and have sought employment in the four-week period ending in the reference week) by the total labour force (sum of employed and unemployed). The resulting value is multiplied by 100 to provide the unemployment rate percentage. Discouraged workers (those who have not sought employment in the past four weeks) are not counted as part of the labour force.

There are three types of unemployment: frictional (workers between different jobs), structural (replaced by a robot, for example) and cyclical (due to the fluctuations in an economy: the business cycle). The first two are unavoidable; you will never have 0% unemployment. There’s also an inverse relationship between GDP and the unemployment rate. As you might expect, when the economy expands (contracts), unemployment decreases (increases).

Generally, when unemployment is low, this is a good thing for the economy. Workers are at work; they earn an income and consume products. Remember, in the US, approximately 70% of the GDP is accounted for consumer spending. Therefore, workers must continue to consume to keep the economy churning along.