Principle Economic Indicators Essay, Research Paper

Principle Economic Indicators

The million (or should we say ‘billion’ now) dollar question is whether or not the United States’ economy will stay in it’s record 107 month expansion (according to the index of leading indicators) or come out of the boom and take a downturn into a recession. Nobody, including the Chairman of the Federal Reserve, Alan Greenspan has a crystal ball to provide insight as to what will happen if interest rates are raised, lowered, or left alone. However, Economists have developed a set of indicators to aid in predicting when a recession is about to occur and when the economy is in one. Indicators should not be mistaken for predictors. They are simply forecasting tools, and like any forecast can be misleading. The index of leading indicators that is reported in the popular press shows our economy is still in an expansion. For the purposes of our evaluation of the economy, we chose the Principle Economic Indicators tracked by the Bureau of Economic Analysis and the U.S. Census Bureau under the Economics and Statistics Administration at the U.S. Department of Commerce. There are thirteen Principle Economic Indicators, and they fall into five major categories: National Output and Income; Orders, Sectoral Production, and Inventories; Consumer Spending; Housing and Construction; and Foreign Trade.

National Output and Income

The first of the five major categories directly relates to measuring the growth of the U.S. economy. National Output and Income consists of the Gross Domestic Product (GDP), Personal Income, and Corporate Profits measurements. GDP is the primary measurement of growth and measures the total amount of goods and services produced by governments, businesses, people, and property located within the United States. Both real (adjusted for inflation) and nominal (current value in dollars) data is collected for computing the GDP. The base year for the real data is 1997. The GDP is normally reported as an annualized quarter-to-quarter change. The reason this measurement is vital to tracking the growth of the U.S. economy is self-explanatory. When the economy is growing, both total income and total output are increasing. Furthermore, a steady increase in the GDP is healthy for the economy. According to the U.S. Department of Commerce, U.S. economic output has grown at an annual rate of 2.5 to 3.5 percent since 1890. The preliminary estimate of GDP in the fourth quarter of 1999 rose at a 6.9 percent annual rate, which is the strongest gain since a similar increase in mid-1996. This is an increase from the initial estimate of 5.8 percent and is consistent with the expectations of analysts. It is also a reflection of the widespread upward increases among the major spending components, including consumer spending, goods exported, and state and local government spending. In the third quarter of 1999, GDP rose 5.7% as a result of increases in Personal Consumption Expenditures, nonresidential fixed investment, and exports.

Personal Income is a measurement of total pretax income earned by individuals, non-profit organizations, and private trust funds. It is expressed at an annual rate also. The more Personal Income increases the greater the potential for the American people to spend and save money, which directly influences the growth of the U.S. economy. Personal Income rose .7 percent in January, following an increase of .3 percent in December. The average monthly increases in 1999 were .5 percent. Some extenuating factors affected income in recent months, including cost of living increases in federal transfer payments, a federal pay raise, and agricultural subsidy payments in January. Real disposable income, income after taxes and adjusted for price changes, increased by .7 percent. There was no change in December. The individual personal saving rate rose from 1 percent in December, which was its low, to 1.4 percent in January. Savings rates generally go down in the months October through May due to Holiday spending (includes “paying off” credit cards).

There are two methods in which Corporate Profits are reported by the government. “Tax-based” profits are derived from corporate tax returns, and “adjusted” profits reflect earnings from current production. Just as increases in Personal Income are vital to the growth of the U.S economy, increases in Corporate Profits are just as important on an even larger scale. The greater the profits, the more potential for growth. This in turn has a direct effect on employment rates, spending, etc. Profits reported from current production increased $3.7 billion in the third quarter of 1999. This is a dramatic improvement from a decrease of $6.5 billion in the second quarter. Profits would have been about $10 billion more than they were in the third quarter if not for the effects of Hurricane Floyd. Insurance companies paid benefits resulting in about $8 billion in reduced profits, with uninsured losses attributing the other $2 billion. Profits before tax increased $18 billion in the third quarter, compared with an increase of $17.7 billion in the second quarter. In light of all data relating to National Output and Income, increases in all measurements suggest the U.S. economy continues to grow at a rapid pace in the first quarter of 2000.

Orders, Sectoral Production, and Inventories

The three measurements that make up this major category are Durable Goods; Manufacturers’ Shipments, Inventories, and Orders; and Manufacturing and Trade Inventories. Durable Goods measures the volume of orders place with U.S. manufacturers for goods with a life expectancy of at least three years. These goods include primary metals, consumer hard goods, transportation equipment, military hardware, and machinery. A large percentage of durable goods purchases in any given year give economists an idea of how many more durable goods will be purchased in the following year. These items don’t break down as easily and are not consumed at the time of purchase, so it is unlikely that a consumer of durable goods will buy that same item again within three or more years. This can affect the economy through the industries that manufacture and sell these items. If they stockpile too many durable goods, there will be more available than there is demand. As a result manufacturers will incur higher inventory costs, while the price for the items will drop because too many are available. This indicator can change if new models or new technologies are introduced that drives consumers to seek replacements for existing items, or if high unemployment or high inflation drives consumers to retain their existing durable goods. This is an indication of trends in consumer preferences for big-ticket items.

Manufacturers’ Shipments, Inventories, and Orders are indicators due to being tied to consumer expectations and new orders for consumer goods, as well as inventory levels. Since this category includes durable and non-durable goods, it encompasses a large percentage of economic activity. Manufacturers ship materials and maintain them in inventory based on the number of orders they anticipate they will receive. It also involves production workers, who are required to take in orders, maintain inventories and perform shipping functions. If there is a large degree of shipments and inventories to maintain, more workers are required. A decrease in orders, inventories and shipments can result in a decrease of personnel required. This affects the economy if unemployment results and potential consumers are unable to purchase as much as they would like. If shipments are delayed, deliveries from suppliers may suffer because they don’t have the raw materials on hand to fill requests. In turn, orders from the manufacturer can be slowed, resulting in customer dissatisfaction and order cancellations. If orders are cancelled after the item is manufactured, then the manufacturer now has additional inventory to maintain, and they may have to hire additional workers or find additional inventory space. This indicator can change as a result of consumer preferences, employment trends affecting the number of skilled workers available for hire, and governmental regulations that can affect methods of shipment.

The Manufacturing and Trade Inventories report indicates the level of business stocks at the retail, wholesale, and manufacturing levels in book value terms. It is essentially a measure of finished goods, not raw materials. If there is a high level of inventory at the retail and wholesale level, this can indicate that consumers do not have sufficient disposable income. This can lead to a downturn in the economy, or it can mean that prices are inflated. It can also mean that a shift in consumer preferences has occurred, e.g. preference for IBM computers versus Apple. A high level of inventory at the manufacturing level indicates that orders are slow or the firm is overstocking inventory. Since inventory space is costly, poor inventory management can result in the need to expand warehouse storage and can result in a decrease of profit. Inventory surpluses at any level affects the economy when stores, wholesalers or manufacturers have to liquidate finished goods at less than the intended selling price, thereby reducing forecasted profit margin. Changes in this indicator are driven by consumer demand and references, which can rapidly deplete inventory or cause inventory to stagnate, and technologies that streamline inventory management and control.

New orders for durable goods declined 2.3 percent in February. They dropped 2.2 percent in January following a 6.5 percent increase in December. The February decrease was a reflection of large declines in orders for transportation equipment, mainly civilian aircraft, and industrial machinery. Despite the volatility of orders and shipments, manufacturing activity appears to be expanding at a good pace in the first quarter of 2000. The Federal Reserve’s index of industrial production suggests that manufacturing production in the first quarter is growing at its strongest pace since 1997.

Consumer Spending

Two of the thirteen principle economic indicators tracked by the Bureau of Economic analysis fall under the category of Consumer Spending. Consumer spending includes Retail Sales and Personal Consumption Expenditures. The Retail Sales economic indicator measures the sales of retail establishments, adjusted for normal seasonal variation, holidays and trading-day differences, and are not annualized. In recent months retail sales have increased faster than expected. February saw an 11.1 percent increase where a 0.9 percent increase was expected, marking the third strong gain in the last four months.

The recent beating that the American public is taking in gasoline prices is undoubtedly the cause for a 4.3 percent increase in service station sales and one reason there has been a strong over all retail sales gains. February sales reached $265.7 billion, an increase of 9.4 percent compared to February of last year. The 11.1 percent average sales increase for January and February has risen at an annual rate that is on track for the largest quarterly growth in the last year. With the exception of six points of quarterly data retail sales have increased a minimum of 5 percent and as much as 13 percent per quarter as compared to the prior quarter since 1994. This steady increase in retail sales indicates public trust in the current American economy. Their willingness to spend their hard-earned money in the retail market instead of acting with increased caution by hoarding funds could be an indication that the general public also has faith that the American economy will continue to prosper in the future.

Increased retail sales are a direct reflection of the level of Personal Consumption Expenditures. Personal Consumption Expenditures economic indicator measures consumer spending for all goods and services in the economic market. These expenditures comprise approximately two-thirds of the total GDP. When viewed as a running average, nearly every quarter since 1995, Real Personal Consumption Expenditures have realized quarterly gains compared to each previous quarter. With the recent increases in retail sales and the continued levels of Personal Consumption Expenditures there is no reason to doubt that our economy can continue it’s creditable levels of growth. These levels of fiscal activity have been and will continue to keep funds moving regularly through the financial sector within the circular flow.

Housing and Construction

Housing Starts and Building Permits are the economic indicator used to measure privately owned housing units started and privately owned housing units authorized by building permits. These are considered good leading indicators of home sales and spending in general. Housing Starts are used to predict the residential investment portion of the GDP. Building Permits usually become Housing Starts in about three to four months. Building Permits are also a component of the leading economic indicators index. Single-family starts account for approximately 74 percent of all starts, and Multi-family units account for the rest.

Monthly construction spending data produced by the Census Bureau are key source data for the GDP. The monthly construction spending data is used as a measure of production in the construction sector. Data on private residential spending are a source for the GDP residential investment component; nonresidential spending data, for nonresidential investment; and public construction spending data, for structures components within government consumption expenditures and gross investment.

Analyst use economic data to forecast other economic series by monitoring various behavioral links due to one type of economic activity generally having an impact on another type of economic activity. For example, an unexpected increase in housing sales will lead to a drop in houses for sale as well as in the months’ supply of houses for sale. If housing stocks decline below desired levels, then builders take out housing permits, initiate housing starts, and work toward completing houses by construction spending. This cycle can differ when production is based on expected changes in the business cycle. Furthermore, housing stocks may be built up in anticipation of housing sales rather than housing being replenished after a rise in sales.

Building permits are one of the indicators of the current status of the economy. The number of residential building permits issued is an indicator of construction activity, which leads to other types of economic production. Before building residential or commercial structures the builder must apply for a building permit. Usually a contractor will apply for a permit at least 6 months in advance. By looking at the number of building permits that have been granted, economist can predict the amount of construction that is likely to begin in the next 6 to 9 months. This is only a prediction, and it could be inaccurate. Acquiring a building permit does not require the contractor to build.

Housing starts increased 1.3 percent to 1.78 million units at an annual rate in February, which is the highest level since January 1999. Single family starts declined 3.9 percent in February, their second decline after hitting a twenty-one year high in December. The multi-family starts jumped 19.2 percent in February, following a 20.4 percent jump in January. Multi-Family starts have risen to their highest level in eleven years.

The tightening of credit in private sector is likely to slow housing activity in the next few months. The interest rate on fixed-rate mortgages has averaged 8 ? percent so far this year, marking its highest rate since the middle of 1996. The homebuilders’ index of prospective buyer’s traffic has been on a downslide since last spring, and sales of new and existing homes have declined since the summer. This is a normal cyclical trend, and building and sales should pick back up in the spring despite increases in mortgage rates.

Foreign Trade

Foreign trade is the economic indicator that measures our economy and GNP against those of other countries the U.S. trades with. The main factor that is tracked is the balance of trade; which is the difference between the value of goods and services a country imports, and the value of the goods and services it exports. This difference will produce what is known as a trade deficit (what occurs when imports exceed exports) or a trade surplus (exports exceed imports).

The flow of the world economy is constantly fluctuating. In order to know precisely what our country’s global economic position is, foreign trade must be measured. The Bureau of Economic Analysis submits monthly reports broadcasting the difference between exports and imports in billions of current dollars. This report, known as the International Trade Balance, analyzes the various international goods and services that are exchanged between countries. When paired with the quarterly Current Account Balance (an updated reading of trade and other certain seasonally adjusted transactions), it provides a powerful tool for economists and government agencies to calculate foreseeable trends. It also allows a gauge for which to adjust shortfalls where economic weaknesses exist and improve international standings. Aside from sustaining our own nations’ powerful trade balance, we provide a positive image with other countries. The U.S. promotes peace and goodwill through exchange. These qualities have an indirect effect on the economy by ensuring that our trade partners have faith in our products and continue to contribute to our economy.

Various factors can cause the foreign trade indicator to change. Exchange rates, quotas, and tariffs are some of the factors that drive change. Whether a country runs a trade deficit or a surplus is dependent on the supply and demand of its goods and services. Political climates can produce trade restrictions with other countries as well. For example, large deficits often provoke nations to prohibit imports. This causes negative impacts that offset the initial purpose of lowering the deficit, such as reducing domestic competition and instilling resentment from other countries. This often leads to trade wars.

Historically, the U.S. has been an economic juggernaut in the trade deficit area. During periods of economic growth, traditionally the U.S. trade deficit increases. According to the most recent BEA quarterly Current Account Balance Report, the January U.S. trade deficit hit an all-time high of $28.0 billion, up from $24.6 billion in December. While exports declined from their December level, imports continued to trend strongly upward. The annual rate deficit totaled $336 billion in January, up from $268 billion this time last year. Of course, higher oil prices were a major contributor to the rising trade deficit. The deficit is predicted to remain high, and the U.S. economy will continue to outpace the economies of its trading partners.

Economic Outlook

The overwhelming trend amongst all thirteen indicators suggests the U.S. economy will continue to stay in a period of economic growth. However, growth leads to increases in spending, which in turn leads to higher inflation rates. Inflation must then be kept in check by adjusting interest rates. National Output and Income levels are increasing at healthy rates suggesting employment rates are strong. The American people are working, making and spending money, and nothing suggests that is going to change any time soon. Manufacturing production is growing at its strongest pace since 1997, according to the Federal Reserve’s index of industrial production. As long as the American people continue spending money, buying goods and services, manufacturers will continue to produce at increasing levels. This in turn reflects the increased levels of Personal Consumption Expenditures and retail sales. Despite increases in mortgage rates, housing starts have increased 1.3 percent to its highest level since January 1999. The American population having increased incomes fosters increased spending, domestic and abroad. This increased level of foreign spending continues to widen the gap in our trade deficit. Another untapped indicator of a booming economy may be the large number of American military members leaving the security of active duty for more lucrative opportunities provided by the private sector. Collectively all these indicators lead us to conclude the U.S. economy will continue to flourish.