ECONOMIC ACTIVITY INDICATORS – HOW DO THEY TALLY?

Here is some background on how the main economic indicators fit together.

GDP – The Core Concept

The broadest measure of economic activity is GDP because it paints the most comprehensive picture of an economy; GDP provides the single measure that encapsulates what we want to know about how activity is and how much the economy can deliver. The integrating framework into which nearly all economic indicators can be fitted is given in the national accounts.

Several Faces to the Same Coin

There are several ways to looking at GDP that correspond to different ways to estimating its size. One is to look at it as a total output of goods and services. This means the total ‘value added’ or what each of the producers add to their inputs. This is the output measure of GDP. On this measure GDP splits into three broad categories: industrial, construction and services value added.

Another way to estimate GDP is to look at the expenditure on total output (excluding spending by residents on imports and including spending by foreigners on exports). This is the expenditure measure of GDP (see diagram below). On this approach, GDP breaks down into consumer spending, government spending, investment, inventories, and net trade (that is, exports minus imports).

A third way to estimate GDP is to aggregate all institutional sectors income (households, companies, government, external sector). Ultimately these three different measures genuinely converge as statisticians accumulate in-depth information on the domestic economy and the balance of payments.

Expenditure Side in the US, but Output Side in Europe

However, the first GDP estimates favour only one side of these approaches. In the US, statisticians rely more on the expenditure side, while Europeans prefer the output side. Hence, in Europe, industrial production and consumer spending (in as much it explains the generation of value added) are thus the key indicators on which to focus in estimating GDP growth.

Correct Interpretation and Analysis

A strong rate of GDP growth and the interpretation of strong will differ between countries – is good news in as much as it means, other things equal, higher profits. However, because a prolonged robust pace of growth puts pressure on capacity – which does not necessarily expand as quickly – it represents an inflationary risk, which can lead to higher interest rates. So, the growth rate of GDP should be strong enough to create wealth, employment, etc., but not so strong as not to generate more inflation than central bankers are ready to tolerate.

The GDP Problem

GDP is released quarterly. Because of the size of the information it encompasses, it is a late indicator. In the best of cases, a flash estimate is released a month or so after the end of each quarter (in the UK). But, usually, it will be published six to ten weeks after the end of the period under review, this, admittedly, is late for analytical purposes.

The GDP Solution

Since GDP data lacks timeliness, attention will typically focus on other data to get a picture of economic activity. These indicators fall into two broad categories: (1) hard data, such as industrial production, retail sales, trade and labour market data; (2) survey evidence from the business sector or from consumers. There remains a snag, however, as none of these indicators provides a complete picture of the concept of GDP. So, get an idea of overall activity, the solution is to cross examine the pieces of information that each indicator provides.

Several Channels

The main relationships the different components of GDP and the various economic indicators (hard economic data, as well as surveys) are illustrated in diagram below. Note that, for simplicity, all the reasoning is done assuming all other things are equal. For instance, traditional surveys will gauge manufacturer’s opinions on current and future levels of output growth inventories etc., which helps form an opinion on industrial production.

On the expenditure side, let us assume labour market data recorded a decline in the unemployment rate. In as much it implies richer and more confident consumers (that is, a boost in consumer confidence and consumer disposable income), this will mean stronger sales and stronger consumer spending. Higher household income also means more tax receipts, which should influence the government balance.