How to use economic indicators

Last week’s post introduced the concept of economic indicators and why you should pay attention to them. This week’s post explains how to actually use them.

As a general rule, with most indicators, you must look for four things: movement, magnitude, trends and context. Each of these tells you something interesting, but you only get the whole story when you look at them together. Let’s use one widely followed indicator, gross domestic product, as an example.

GDP is the broadest measure of the economy available. It captures the total value of all goods and services sold within a country during a certain period of time. Think of it as a sort of overall grade of the country’s economic performance. It is reported in one of two ways, as an annual rate of growth and as a quarterly rate of growth.

Figures are reported four times per year. Here in South Africa, Statistics South Africa (Stats SA) releases the January to March (Q1) figures in April, the April to June (Q2) figures in July and so on through to the end of the year. We’ll examine 2011’s third quarter release here as an example.

On 29 November 2011, Stats SA reported that South Africa’s GDP grew 1.4 percent in the third quarter of 2011. So, looking at movement first we see that the number is positive. This immediately tells us that the economy grew. That’s good news. A negative number would mean that the economy shrank. But the story doesn’t end there.

Next we look at magnitude. Here we focus on the number itself, 1.4 percent. This tells us that the economy was 1.4 percent larger during the third quarter of 2011 than it was during the second quarter of 2011. Here it seems the news might not be as good. Sure, the economy grew, but only slightly. China’s growth during the third quarter, for example, was 9.1 percent. Clearly we need to dig a little deeper.

Knowing the one quarterly number in isolation tells us something, but not enough. For us to really know something useful, we need to look at the trends. We know that GDP grew by 1.4% in the third quarter of 2011, but what about the earlier six months of the year? It turns out that the economy grew at 1.3 percent in the April to June quarter, but by 4.6 percent during the previous three months of the year. Our story appears to be getting grimmer. The economy slowed as the year rolled on.

Looking at a longer-term trend tells us even more. Between 1993 and 2011, South Africa’s quarterly GDP growth averaged 3.3 percent, so our 1.4 percent number is not looking good at all. Growth in the third quarter of 2011, it seems, was well below the country’s long-term average.

Knowing where an economic indicator sits in relation to its long-term performance tells us a lot. In the case of GDP, a number well below the long-term trend tells us that the economy is running slowly. This can lead to higher unemployment – already a huge problem in South Africa – and lower spending. Conversely, a number well above the long-term trend can signal an overheating economy, a precursor to inflation (unsustainable price rises) and a possible interest rates hike.

Now that we know the direction of the economy\s movement, the size of the movement, and where the number sits within the long-term trend, it’s time to look at context. Here, it helps to read through the newspaper articles covering the GDP figures’ release.

Most of the mainstream media articles on the topic would, in some way, shape or form, have reminded readers that, in December 2010, President Jacob Zuma’s administration pledged to create 5 million new jobs in South Africa by 2020. To do this, officials estimated at the time, our economy would have to grow at 7 percent per year for the entire 10-year period.

When armed with this background knowledge, this context, we realise how bad the 1.4 percent figure really is. This final piece of the puzzle is in many ways the most important one. Context tells us how the piece of information we are looking at fits with other variables that affect our economic lives.

This applies not only to GDP, our example here, but to all of the economic indicators we’ll examine in future posts. Each entry I present will contain the information you need to understand the movement, magnitude, trends and context of each indicator presented. Taken together, the indicators presented in this blog will give you a good idea of where South Africa’s economy has been, where it is at present, and where it is likely to go in the future.

Next week, we’ll look at consumer confidence.