Understanding Key Economic Indicators

If you've ever watched CNBC or read the business page in the newspaper, you might think you had landed in another country. Consumer price index, producer price index, gross domestic product, inflation, deflation! What are they talking about? It all sounds like Greek to me! How can I make sense of all this? Well, be assured that you are not alone. Most people struggle to make sense of this financial jargon. All these terms are called 'key economic indicators'. The good news is that, even though there are more economic indicators than you can shake a stick at, you don't need to understand them all!

Simply put, economic indicators are statistics about the economy that give us some idea how the economy is doing right now and maybe some idea where it might be going in the near future. And there is only a handful you need to know about. An understanding of these indicators can help you grasp basic financial news and help you make wiser, more informed decisions about your personal finances. So let's try to cut through the static and explain them is terms everyone can grasp. The following indicators apply to the American economy but most developed nations have their equivalent.

Balance of Payments

The Balance of Payments indicator is a measure of the trade performance of the economy. Trade is simply the buying and selling of goods and services between countries. It measures the money coming into the country from the sale of goods, services and investment overseas (exports) as well as the money leaving the country due to the purchase of goods, services and investments from overseas (imports).

When a country imports more goods and services than it exports it is running a trade deficit. When a country exports more than it imports the country is running a trade surplus. The Balance of Payments indicator fluctuates from month to month and season to season but a long term deficit is generally not good for the economy. As domestic dollars flow out of the country and overseas, it funds employment, expansion and investment over there stimulating their economy. A trade surplus results in more money coming here for employment, expansion and investment helping to stimulate our own economy.

These statistics can be found at the Bureau of Economic Analysis website.

Gross Domestic Product

The Gross Domestic Product (GDP) is a basic measure of a country's economic performance. It is generally defined as the market value of all the goods and services produced by a country. While it is not an indicator of the standard of living, countries try to increase their GDP to increase their standard of living. Most countries try to maintain a 2-3% annual growth in the GDP to support increased economic activity. A GDP of 1% or less may not be enough to support increased economic growth and may lead to job cuts.

The GDP is released by the Bureau of Economic Analysis, a part of the the US Department of Commerce.

Employment Report

The Employment Report is usually released on the first Friday of the month and can have a significant impact on the markets. If the report is better than expected, it is generally considered good for the stock market. If it is weaker, this is generally considered good for the bond market.

The current employment statistics can be found at the Bureau of Labor Statistics website.

Housing Starts and Building Permits

Housing starts is a measure of how many residential units began construction in the previous month. 'Start' in this context means excavation of the foundation for a building used primarily as a residence. This figure is released by the US Department of Commerce around the 16th of each month at 8:30 AM EST. Building permits are also a measure of housing starts. Because each state does not require a building permit before construction actually begins, housing starts is a better measure to follow.

Housing starts are a key economic indicator because it affects so many other areas of the economy (retail, manufacturing, utilities, employment, etc). When housing starts increase over time jobs are created, demand for utilities and building materials increase, furniture is sold and much more. All this is good for the economy.

Producer Price Index

The Producer Price Index (PPI) is actually a group of indexes that measure the average change over time of the prices that domestic producers receive for their goods and services. In other words, the PPI measures price changes from the perspective of the seller. The PPI is produced by the US Bureau of Labor Statistics. There are over 8000 PPI for separate products and groups of products released every month.

When the PPI goes up, it means that the producers of goods and services are paying more to produce their goods and services. Typically, these increased costs are passed on to the consumer in the form of higher prices. The PPI is a prime inflation indicator and is also used as an indicator of which way the CPI may move. The PPI is usually released at 8:30 AM EST around the 16th of each month.

Consumer Price Index

The Consumer Price Index (CPI) measures prices change of consumer goods and services from the perspective of the buyer. It measures the cost of a typical 'basket' of goods and services such as food, transportation and medical care for the average American household. When the CPI goes up, it means that you and I are paying more for the goods and services we purchase.

The CPI is one of the most often used measures for identifying inflationary or deflationary periods. Large rises in CPI during a short period typically indicate periods of inflation and large drops in CPI during a short period of time usually indicate periods of deflation.

You may also hear the CPI sometimes referred to as 'headline inflation'. The CPI is produced by the US Bureau of Labor Statistics and is usually released at 8:30 AM EST a few days after the PPI is released.

Retail Sales

Retail sales are a measure of the total receipts (sales) from retail stores. It is a good indicator of consumer sentiment about the economy. If the public feels confident about their jobs and the future of the economy, they are more willing to spend and this will be reflected in this indicator. If the public is generally pessimistic about the economy, they will buy less and this indicator will go down.'

Positive retail sales numbers give the impression that consumers are going back to spending and stimulating the economy in the process. The markets will react positively to this scenario. Negative retails sales numbers indicate the consumer is hesitant to spend with the resultant negative effect on the economy. The markets tend to fall upon this news.

The retail sales figures for the previous month typically are released around the 13th of each month at 8:30 AM EST.

Inflation

Inflation is defined as a sustained increase in the level of prices for goods and services. It is measured as an annual percentage increase. Inflation decreases the purchasing power of the dollar. For example, if the current inflation rate is 4%, then a $1 candy bar would cost $1.04 next year.

As prices for the raw materials and goods that manufacturers require rise, they must increase the prices of the goods and services to compensate. Of course, these price increases are passed along to you, the consumer.

Inflation is particularly hurtful to those, like retirees, on fixed incomes. Each year, inflation eats aware at the buying power of their fixed incomes. I am fortunate enough to work at a place that provides periodic COLA. COLA stands for Cost of Living Allowance and is a percentage pay increase equal to or near the current inflation rate. It helps eliminate or reduce the effect of inflation on income.

Deflation

Deflation is the opposite of inflation or a sustained decrease in the prices of goods and services. While this sounds good at first, it can be problematic. Sustained deflation can feed a deflationary spiral which can lead to recession.

When prices drop, consumers have reason to delay purchases looking for even better prices. This reduces overall economic activity. As purchasing drops, manufacturers reduce production, which causes a reduction in investment, which leads to layoffs, which leads to further reduction in demand. This 'deflationary spiral' can lead to recession, if left unchecked.

Anticipation of an Indicators Release

You will often hear that the markets react this way or that 'in anticipation' of the release of this month's employment figures, Producer Price Index or whatever. The market, as a whole, has certain expectations about which way a particular indicator will move. If an indicator doesn't move the expected direction or move enough in the expected direction, the markets may react wildly.

Knowing when the various economic indicators are released can help you to be prepared and anticipate market movements in advance. The US Bureau of Labor Statistics releases a number of these indicators and the most recent figures can be found on their homepage.

Putting Indicators to Use

Of course, there are many, many more economic indicators out there. Many are highly targeted to specific audiences and you are safe ignoring them. Clearly, though, the more you understand the better prepared you will be to make wise financial decisions in both good and bad economic times.

So the next time you click past CNBC on the tube or reach the financial page in the paper don't just move on. Stop, pay attention and see if it all makes more sense now. Understanding the basic key economic indicators won't do you any good until you begin to apply them to your situation. You may be surprised just how interesting the financial news can be when you begin to understand how the pieces fit together!

Richard Stephen

Richard writes on a number of topics including personal finance, investing, sports and technology. He resides in Southern California with his wife and 3 children. By day he works as an IT Project Coordinator.

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