Economic indicators provide key insights into the health and trajectory of the economy. Knowing how to interpret these indicators can help individuals understand the economic landscape and make informed financial decisions that impact their wallet. While the economy may seem abstract, it directly affects everyday factors like job prospects, prices, wages, and interest rates.
The major economic indicators cover broad areas like gross domestic product (GDP), unemployment, inflation, consumer sentiment, manufacturing, and housing. These metrics are closely watched by policymakers, businesses, investors and consumers. Shifts in the data can sway major decisions impacting growth, profits, and personal finance.
Understanding what the key indicators mean and how they relate to your financial situation empowers you to make smart money moves. When job numbers are up, you may decide to change careers or ask for a raise. When inflation is high, you may choose to reduce spending or delay a major purchase. As interest rates rise, you may want to pay off variable-rate debt.
In this article, we’ll explore the top economic indicators, what they measure, and how the trends could impact your wallet and financial wellbeing. Knowledge is power when it comes to navigating the macro forces shaping your money.
GDP: Gross Domestic Product
Gross Domestic Product (GDP) measures the total value of all goods and services produced within a country during a specific time period, typically annually or quarterly. It is considered one of the most comprehensive indicators of a country’s economic health and growth.
GDP is calculated by adding up four components:
- Consumer spending on goods and services
- Business investments
- Government spending
- Net exports (exports minus imports)
The GDP growth rate indicates how fast the economy is growing or shrinking. A positive growth rate indicates the economy is expanding, while a negative rate signifies a contracting economy. The U.S. GDP growth rate has averaged around 2-3% annually since World War 2. During recessions, GDP growth can turn negative, while growth over 4% is considered high.
GDP growth impacts personal finances in several ways:
- Job creation – Faster GDP growth leads to more jobs and lower unemployment. This makes it easier for people to find work.
- Wage growth – Stronger economic growth allows employers to pay higher wages. Workers see increases in their take-home pay.
- Stock market returns – GDP growth fuels corporate earnings and stock prices. Retirement accounts and other investments benefit from rising markets.
- Interest rates – Rapid GDP growth leads the Federal Reserve to raise interest rates to prevent overheating. Higher interest rates result in increased costs of borrowing money.
- Inflation – Faster economic growth can spark higher inflation, eroding purchasing power. Consumers pay more for everyday goods.
By tracking GDP reports, individuals can gauge the overall health of the economy and how it might impact their personal finances in the months ahead.
Unemployment Rate
The unemployment rate measures the percentage of people in the labor force who are unemployed and actively seeking work. It is one of the most widely followed economic indicators.
The current unemployment rate is around 3.5%, which is near historic lows. This tight labor market has led to wage growth and more job opportunities for workers. When unemployment is low, employers have to compete for talent, driving up wages. This gives workers more disposable income to spend, boosting economic growth.
However, an extremely low unemployment rate could also lead to an overheated economy and higher inflation. If too many jobs are going unfilled, employers may raise prices to offset higher wage costs. The Federal Reserve often raises interest rates when unemployment drops below 5%, trying to cool off the economy and control inflation.
The ideal unemployment rate considered healthy for the economy is around 4-5%. This balances solid job opportunities for workers with labor market slack needed to control inflation. When unemployment spikes higher, it signals an economic downturn. Layoffs rise as consumer spending drops, creating a vicious cycle.
The unemployment rate is a critical indicator of the job market’s strength. For individuals, it impacts your bargaining power and earnings potential. When unemployment is low, it’s easier to find jobs and negotiate higher pay. For the overall economy, managing unemployment helps ensure stable growth without excessive inflation.
Inflation Rate
Inflation refers to a general increase in prices for goods and services across an economy. It is typically measured by calculating the Consumer Price Index (CPI), which tracks the prices paid by urban consumers for a representative basket of goods and services.
The CPI is calculated by the Bureau of Labor Statistics (BLS) each month. BLS data collectors visit or call thousands of retail stores, rental units, and service providers to track prices. All of the price data is then weighted and compiled into a single inflation rate.
Over the past year, inflation has been unusually high due to factors like supply chain disruptions, labor shortages, and surging demand as economies reopen. The inflation rate reached a 40-year high of 9.1% in June 2022 on an annualized basis.
High inflation erodes consumer purchasing power. When prices rise faster than incomes, consumers cannot buy as many goods and services. High inflation also increases the cost of living, requiring more money for necessities like food, gas, housing, and healthcare. This disproportionately impacts lower income families who spend a larger share of their budgets on essentials.
To combat high inflation, the Federal Reserve has been raising interest rates to slow economic growth and demand. However, higher rates also increase borrowing costs for consumers and businesses. The ideal goal is to bring inflation back down to a more sustainable 2-3% range.
Interest Rates
The Federal Reserve plays a key role in setting interest rates in the United States. They do this through their Federal Open Market Committee (FOMC), which meets regularly to assess the economy and determine where to set their target federal funds rate. This rate influences the prime rate that banks charge consumers and businesses for loans.
Currently, interest rates remain relatively low by historical standards, though the Fed has been raising rates since 2015 after keeping them near zero in the years following the Great Recession. As of 2022, the target federal funds rate set by the FOMC stands between 1.50-1.75%. This is still quite low compared to rates of 5-6% that were common in the decades preceding the 2008 financial crisis.
Changes in interest rates have a significant impact on consumers and the economy. Lower rates make it cheaper for consumers to finance major purchases like homes and cars through mortgages and auto loans. Lower rates also reduce the cost of borrowing for businesses to expand. However, lower rates provide less incentive for consumers to save and generate less income for savers.
Higher interest rates have the opposite effect. Mortgages, credit cards, and other loans become more expensive. This reduces borrowing and spending in the economy. However, higher rates provide more incentive for consumers to save and generate more income for savers. The Fed tries to strike a balance by raising rates to prevent inflation but avoiding increases that might unduly slow economic growth.
Consumer Sentiment
Consumer sentiment refers to the overall attitude and confidence that consumers have about the economy and their personal finances. It is considered a leading indicator of consumer spending.
Consumer sentiment is measured through surveys that ask consumers questions about how they feel about the economy, their current financial situations, and whether they think it’s a good time to make major purchases. Two of the most closely watched consumer sentiment surveys are conducted by the University of Michigan and The Conference Board.
The University of Michigan’s survey asks around 500 consumers each month questions like whether they think their family’s financial situation will improve over the next year. The Conference Board’s survey asks 5,000 households questions about business and employment conditions as well as their plans for major purchases.
The consumer sentiment indexes are calculated from the survey results. A higher number indicates more optimism among consumers, while a lower number signals more pessimism.
Consumer sentiment is important because consumer spending accounts for about 70% of U.S. economic activity. When sentiment is high, consumers tend to spend more freely. When sentiment declines, consumers tend to pull back on spending and increase saving.
Economists watch consumer sentiment indexes closely because they can provide insight into future consumer spending patterns. If the indexes start trending lower, it may signal weaker retail sales and economic growth ahead. On the other hand, rising sentiment bodes well for consumer spending and the economy.
Understanding consumer sentiment can help inform spending and investing decisions. When sentiment is high, it may be a good time to make major purchases or investments in consumer discretionary sectors like retail, automobiles, and housing. When sentiment is declining, it may be prudent to reduce spending, increase saving, and shift investments to more defensive sectors.
Manufacturing Activity
Manufacturing activity provides insight into the health of the economy. Key indicators like the Purchasing Managers’ Index (PMI) track month-to-month changes in manufacturing activity based on surveys of purchasing managers. A PMI reading above 50 indicates expansion in the manufacturing sector, while a reading below 50 signals contraction.
The Institute for Supply Management’s PMI is considered one of the most important economic indicators. It covers critical metrics like new orders, production, employment, deliveries, and inventory. Strong manufacturing activity points to business investment, job creation in related sectors, and demand for exported goods.
In recent years, the PMI has indicated steady expansion in manufacturing following the sharp contraction during the Great Recession. However, the manufacturing sector faces ongoing challenges including foreign competition, rising costs, and supply chain disruptions. The US maintains a competitive edge in advanced manufacturing sectors like aerospace, pharmaceuticals, and technology hardware. Investments in automation, training, and emerging technologies will be key to bolstering manufacturing despite globalization trends.
A thriving manufacturing sector provides well-paying jobs, boosts innovation, and reduces dependence on imports. Monitoring manufacturing indexes can indicate the overall direction of the economy and impact consumer sentiment. Individuals may see effects on employment prospects and wages if manufacturing dramatically expands or contracts for a sustained period.
Housing Starts
Housing starts measure the number of new residential construction projects that have begun in a given period. It is an important leading economic indicator that signals the health of the housing sector and overall economy.
Housing construction is cyclical and sensitive to interest rates and economic conditions. When the economy is strong, more people have jobs and income to afford housing, so housing starts increase to meet demand. During recessions, unemployment rises so fewer people buy homes, causing housing starts to decline.
Trends in housing starts provide insight into future economic growth. Rising housing starts indicate an expanding economy as construction activity rises and consumers feel optimistic to purchase homes. Falling housing starts signal a contracting economy as fewer homes are being built amidst weak demand.
Housing is also interrelated with other key sectors like manufacturing and retail. A booming housing market creates demand for construction materials, furniture and home goods. Growth in housing starts leads to more jobs and income for construction workers, manufacturers, and retailers – boosting overall economic activity.
On the other hand, a weak housing market negatively impacts the economy. Declining construction and home sales lead builders, real estate agents and related industries to cut jobs and spending. This creates a ripple effect of less disposable income and reduced consumer demand.
Monitoring housing starts helps gauge the health of the critical housing sector and its potential influence on the broader economy. Rising housing starts indicates economic expansion ahead, while falling starts may signal an impending downturn. Understanding trends in housing starts provides valuable insight for consumers on future income, jobs and spending power.
Retail Sales
Retail sales are a key economic indicator that measures the total receipts of retail stores each month. The retail sales report provides insight into consumer spending trends and the overall health of the economy.
The Commerce Department releases the monthly retail sales report around the middle of each month. It tracks sales at retail stores across the country, excluding automobiles, gasoline stations, and restaurants. The headline number shows the percentage change in retail sales from the previous month.
Monthly retail sales offer a timely snapshot of consumer spending, which accounts for over two-thirds of economic activity in the United States. When consumers feel confident about the economy, they tend to spend more freely on discretionary purchases. Higher retail sales suggest rising consumer confidence and economic expansion. Conversely, declining retail sales could signal a pullback in consumer spending and potential economic contraction.
Trends in retail sales correlate closely with GDP growth. Consumer spending is the primary engine that powers economic growth in the U.S. Strong retail sales numbers indicate consumers have money to spend and feel optimistic, fueling broader economic growth. Weak retail sales can be an early warning sign of an impending slowdown or recession.
Monitoring retail sales gives policymakers, businesses, and investors insight into the direction of consumer spending and overall economic health. Healthy gains in retail sales point to economic strength, while sluggish retail sales may prompt interest rate cuts or other stimulus measures to boost spending and growth.
Conclusion
The major economic indicators we’ve discussed all have an impact on our personal finances and financial wellbeing. While the economy is complex, keeping an eye on key metrics can help us understand where things may be headed.
The GDP gives insight into overall economic growth and productivity. If GDP is rising steadily, it’s a positive sign of economic expansion which may translate to more jobs and opportunities. However, fast GDP growth could also lead to inflationary pressures.
The unemployment rate directly impacts how easy or difficult it may be to find a job if needed. Lower unemployment also tends to correlate with higher wages as employers compete for workers.
Inflation eats away at the purchasing power of our money over time. When inflation is high, our dollars don’t go as far. Interest rates also correlate strongly with inflation. Rising rates make borrowing more expensive.
Consumer sentiment reveals how confident people feel about spending versus saving. Strong consumer sentiment supports economic growth, while weak sentiment can precede recessions.
Manufacturing activity gives insight into industrial production and demand for raw materials. Growth in manufacturing is generally positive for the broader economy.
Housing market indicators like housing starts influence real estate values and access to credit. Strong housing markets support construction jobs and related industries.
Retail sales show how willing and able consumers feel to spend money. Robust retail sales allow retailers to hire more and expand operations.
For most individuals, the unemployment rate and inflation are likely the most important indicators to follow routinely. These two metrics have an outsized impact on our job prospects and cost of living. However, it’s wise to keep an eye on the bigger picture painted by all the key indicators together. Understanding the broader economic context helps us make smarter financial decisions.
