Leading Economic Index (LEI)

The Leading Economic Index (LEI) is a composite index published monthly by the Conference Board, an independent research association. It is designed to anticipate changes in the economic cycle and forecast future economic activity. As a crucial tool in economic analysis, it aggregates multiple economic indicators that historically have moved before changes in the overall economy, hence the term “leading.”

Components of LEI

As of the latest methodology update, the LEI comprises ten components:

  1. Average weekly hours, manufacturing: This gives insight into labor market conditions. An increase usually indicates that employers are gearing up for higher demand.
  2. Average weekly initial claims for unemployment insurance: This is a measure of layoffs. A rise usually suggests weakening economic activity, while a fall implies an improvement.
  3. Manufacturers’ new orders, consumer goods and materials: Increased new orders can indicate higher production levels in the future.
  4. ISM Index of New Orders: The Institute for Supply Management’s index provides insights into manufacturing sector activities and future production.
  5. Manufacturers’ new orders, non-defense capital goods excluding aircraft: This often signals future business investment.
  6. Building permits, new private housing units: Housing sector activity is a major economic driver; more permits suggest future construction activity.
  7. Stock prices, 500 common stocks: Stock market performance can reflect investor sentiment and future economic expectations.
  8. Leading Credit Index: Comprised of six financial indicators, it provides information on the state of the credit markets.
  9. Interest rate spread, 10-year Treasury bonds less federal funds: A larger spread generally indicates more robust future economic activity.
  10. Average consumer expectations for business conditions: This leverages components of consumer confidence surveys.

Purpose and Use

The LEI’s primary purpose is to predict economic activity over the next 3 to 12 months by providing a broad view that combines various leading indicators. It is particularly useful for identifying turning points in the economy, such as troughs and peaks. Economists, businesses, and policymakers use the LEI for purposes such as:

Methodology

The Conference Board periodically reviews and updates the methodology of the LEI to ensure it captures the most relevant leading indicators. The methodology involves several steps:

  1. Selection of Components: Indicators are selected based on economic theory, empirical results, and statistical robustness.
  2. Normalization and Smoothing: Data are normalized to account for different magnitudes and smoothed to reduce volatility.
  3. Weight Assignment: Each component is assigned a weight, typically based on its historical correlation with future economic activity.
  4. Composite Construction: The final composite index is calculated as a weighted average of the normalized, smoothed components.

Historical Performance

Historically, the LEI has been a reliable predictive tool for identifying economic phases. For example, it successfully signaled the onset of several recessions, including the global financial crisis of 2007-2008. However, it is important to note that while the LEI is a useful tool, it is not infallible and occasionally produces false signals.

Inflation and LEI

One of the critical interactions is between the LEI and inflation trends. Generally, an improving LEI suggests rising economic activity, which can put upward pressure on prices. Conversely, declining LEI figures could signal weaker economic growth and potential disinflationary trends. Central banks closely monitor these dynamics to balance growth and inflation targets.

As of the most recent reports, the LEI in the United States has shown mixed signals post the COVID-19 pandemic recovery. While some indicators such as stock prices and new orders have rebounded strongly, others like building permits and average weekly hours have been more volatile, reflecting ongoing uncertainties in global supply chains and labor markets.

Global Variants

While the Conference Board’s LEI for the United States is the most widely known, there are similar indices for other economies which also serve as leading indicators for their respective economic cycles. Examples include:

Criticisms and Limitations

Despite its widespread use, the LEI is not without criticisms:

Conclusion

The Leading Economic Index is an invaluable tool for predicting economic activity, offering a synthesis of various leading economic indicators into a single, cohesive measure. Its broad application across economic forecasting, business planning, and policy formulation underscores its significance. However, users must be cautious of its limitations and use it in conjunction with other analytical tools for the best results.

For more information, visit the Conference Board’s official website: The Conference Board.