Leading Indicator Definition

Leading indicators are a set of statistics about economic activities that help in macroeconomic forecasts of the economy and emerging stages of business cycles across the industry by acting as a variable with economic linkage. It provides early signs of turning points in business cycles that precede coincident and lagging indicators.

How are Leading Indicators Helpful?

For macro-economic policy decision-making, it is necessary to know the state of the economic cycle, i.e., whether the economy is in the expansionary phase or whether it is moving towards the recessionary stage so that countercyclical stabilization policies can be implemented. For understanding the same, different data points of a series of economic variables are used, giving information about the economy’s state in past, present, and future predictions. These data points are called economic indicators.

Economic indicators are categorized based on their timings into three; leading indicators that forecast economic activities’ turning points, coincident indicators that give a real-time state of economic activities, and lagging indicatorsLagging IndicatorsLagging indicators are used to identify long-term trends or economic patterns by referencing to a series of economic activities that occurred in the past. They can’t predict the future because lagging indicators only shift when major economic events occur.read more that reflect past economic activities.

Leading indicators help economists predict the future trajectory of economic activities by forecasting the direction of GDP and thus help in better macro-economic policy decision-making.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Leading Indicators (wallstreetmojo.com)

Leading Indicator Examples

Given below are the examples –

US economy list of indicators

Germany economy list of indicators

Leading Indicators Methodology

Burns and Mitchell first brought out the leading indicator approach post-1930 depression. Economic Cycle Research Institute (ECRI), founded by Dr. Geoffrey Moore, established the first list of 8 indicators viz, commodity prices of sensitive commodities, average workweek of Manufacturing, building contracts, new incorporations of companies, orders released, housing statistics, index of stock prices, liabilities due to business failures.

Later, the US conference board started publishing these indicators. Finally, from 1980, the Organization of Economic Cooperation and Development (OECD) started publishing the CLI (Composite Leading Indicator) index for major countries.

  • The first stage of leading indicator identification and indexing is identifying the growth cycles. An adjustment needs to be made for seasonality and short-term irregularities in the growth cycle. The second is to identify turning points determined by Bry and Boschan and the Artis et al. rule.Next, turning point indicators are assessed for quality by measuring the efficiency of leads through mean and standard deviation. Further analysis is done to identify indicators as per OECD guidelines, viz, cross-correlation, coherence and mean delay, dynamic factor analysis, common component variable, cyclical classifications. Self-organizing maps can also be used for the selection of lead indicators.After selecting lead indicators, an index is developed to analyze and compare the movements. The index is developed through linear and nonlinear frameworks. The linear framework can be created using the diffusion index – measuring the proportion of indicators of economic activities that are experiencing expansion in a given period.

Other methods are the Stock and Watson approach which uses a common trend principle. Autoregressive distributed lag method, which uses GDP as a reference point. Nonlinear frameworks are a Probit model or logistics model where discrete regression analysis is used, Markov – switching autoregressive model is also used.

Benefits

  • Helps in identifying and predicting future trends and events in the economy. They are used for forecasting the overall economic activity.Help in identifying and tracking the growth cycles in the economy.Help to take corrective measures in advance to counter economic trends.Lead indicators help in macroeconomic policy decisions.Monetary policy frameworkMonetary Policy FrameworkMonetary policy refers to the steps taken by a country’s central bank to control the money supply for economic stability. For example, policymakers manipulate money circulation for increasing employment, GDP, price stability by using tools such as interest rates, reserves, bonds, etc.read more can be used as a countercyclical measure by relying on lead indicatorsLead indicators provide adequate early warnings of cyclical indicators of economic activities.Help in getting the overall view of the economy, unlike the lagging indicators, which focus on short-term performance.

Limitations

  • These indicators are difficult to identify.Leading indicator measurement is difficult and may not be accurate.It involves qualitative factors and accurate quantification of the same may be difficult.Validation of lead indicators may be a challenge and they may not match closely with actuals.

Conclusion

Leading indicators are dynamic variables which help in identifying turning points in eLeading indicators are dynamic variables that help identify turning points in economic activities. Prediction of economic trends is possible by tracking such indicators through an appropriate index. However, as they are inaccurate, the actuals may not be equivalent to lead indicators. Lead indicators help in designing macro-economic policies by countercyclical policies to tackle economic cycles of boom and bustsCycles Of Boom And BustsBoom and Bust Cycle is the Gross Domestic Product (GDP) cycle of upward and downward movements along with its long term trend. It helps identify the level of production in the economy and the performance of the associated economic indicators such as employment, inflation, stock performance, and investor behavior.read more.

They can provide early signs of upturn or downturn in GDP. Investors and government bodies can use these indicators to predict the economy’s direction and make importing investing and policy decisions. It thus helps in taking proactive actions to achieve economic and other strategic goals.

This has been a guide to what are leading indicators and their definition. Here we discuss the need and methodology for leading indicators and the examples. You can learn more about finance from the following articles –

  • Types of Market IndicatorsUnemployment CompensationMacro Environment DefinitionCompare – Leading vs Lagging Indicators