In a recent post, my Café colleague Margaret O'Hanlon made a strong argument about understanding broader economic trends: "you have a shot at becoming a more trusted advisor if you understand what's shaping the economy shapes your company's financial and operational plans, which is shaping the company's staffing and reward plans, and so on..." She encourages readers to stay up-to-date on the economic outlook.
I completely agree; you should stay up-to-date on the economic outlook. But it's easier said than done. When there are so many voices in the forecasting space, how do you know which one to listen to? Who should be your trusted advisor?
In truth, it's hard to know. In his 1974 Nobel prize acceptance speech, Friedrich Hayek stated that "[i]t is often difficult enough for the expert, and certainly in many instances impossible for the layman, to distinguish between legitimate and illegitimate claims advanced in the name of science." Hayek describes how the scientistic error - economists' propensity to present their findings with the certainty of scientific language - led to some of the "gravest errors of economic policy." He provides a dismal commentary on the dismal science: "[w]e have indeed at the moment little cause for pride: as a profession we have made a mess of things."
I don't mean to throw my profession under the bus, but Hayek isn't wrong... When sorting through all of the prognostication that is certain to come, like it always does at the end of every year, it's hard to know who to trust. We, as economists, don't have a great track record. To try and clean up the mess we've made, I've put together a quick guide to critically evaluating some of the key economic indicators that may be coming your way.
Employment
What It Is: Employment is seen by many as the most important indicator of the health of the economy. The U.S. Bureau of Labor Statistics releases a jobs report on the first Friday of each month. The jobs report indicates the current unemployment rate and how many jobs gave been gained or lost in the economy.
Why it's important: Consumers make up nearly 70% of economic activity in the US. The employment situation of these consumers has a strong influence on the level of economic activity. The basic idea is that when people are out of work, they cut back on their purchases, which affects corporate profits.
What to consider: Employment statistics depend heavily on definitions. For example, the unemployment rate tells us the number of individuals who are "actively seeking work." It doesn't tell us about the number of discouraged workers, the number of workers who are part-time and would prefer full-time work, the number of workers who are underemployed (in terms of their skills and abilities), or where (industries or occupations) job losses or job growth will take place.
Where to learn more: Projections Overview and Highlights, 2016-26, Bureau of Labor Statistics, U.S. Department of Labor
Inflation
What It Is: Inflation measures changes in prices. The Consumer Price Index (CPI) measures changes in consumer prices and attempts to measure the degree to which life is becoming more expensive for the typical consumer. The Producer Price Index (PPI) attempts to measure changes in the prices of producer goods. I
Why it's important: Again, it comes back to the consumers. Increases in the CPI mean that because things are more expensive, consumers are more likely to cut back on their purchases, which affects corporate profits. Increases in the PPI mean that companies are more likely to pass these price increases to consumers, which further fuels increases in the CPI.
What to consider: Different measures of the CPI and PPI include different "baskets" of goods from different industries. The food and energy industries are known to be particularly volatile. If these industries are included in the "basket" of goods, the resulting metric may be more volatile. Consider looking at baskets excluding food and energy. Additionally, there is a "sweet spot" when it comes to inflation; too much inflation is bad, but deflation is bad too. Deflation can lead to decreased revenues for companies, which may translate into layoffs.
Where to learn more: Consumer Price Index and Producer Price Index, Bureau of Labor Statistics, U.S. Department of Labor
Consumer Confidence
What It Is: Consumer confidence is the degree of optimism regarding the state of the economy that consumers are expressing through their spending and saving activities. The Consumer Confidence Index (CCI) looks at consumers' opinions on current economic conditions (40%) and expectations about future economic conditions (60%).
Why it's important: Yet again, it comes back to the consumer. The basic idea is that when consumers feel confident about their future economic prospects, they are more likely to spend. When they feel less confident, they are less likely to spend. When consumers don't spend, corporate profits are negatively impacted.
What to consider: Some economists consider the CCI to be a leading indicator, or a predictor of future economic activity. Others, however, view it as a lagging indicator, or a measure of what has already happened. The argument here is that it takes time for consumers to respond to economic events. Increases in spending today may be the result of an economy that recovered several months ago. Decreases in spending may be adjustments to a recession that started several months ago. The CCI doesn't tell us what's going to happen; it tells us what already happened and if it can be expected to continue.
Where to learn more: Consumer Confidence Index, The Conference Board
The bottom line is caveat emptor - be skeptical and ask questions. Just because it sounds like science doesn't mean it is science.
Stephanie Thomas, Ph.D., is a Lecturer in the Department of Economics at Cornell University. She teaches undergraduate and graduate courses on economic theory and labor economics in the College of Arts and Sciences and in Cornell’s School of Industrial and Labor Relations. Throughout her career, Stephanie has completed research on a variety of topics including wage determination, pay gaps and inequality, and performance-based compensation systems. She frequently provides expert commentary in media outlets such as The New York Times, CBC, and NPR, and has published papers in a variety of journals.
Nice treatment of this topic by Stephanie. In her current capacity, I'm sure Stephanie has heard the quote attributed to Harry Truman, " . . give me a one-handed economist". The phrase clearly expressed Truman's frustration with economists and their predisposition to (correctly) say, 'on the one hand...on the other'. There's no question . . . it's complicated.
Again, this was good - and Stephanie listed the "usual suspects" in what's the generally-accepted order, and where Employment is generally acknowledged as the economic driver/engine. Which in-turn spawns Inflation, which will ripple through the economy and increase wages AND prices. And a little inflation is in fact desirable - and way more so that a little deflation.
For the past 20 years, I've worried that most (okay, many) compensation professionals have what amounts to a substandard understanding of micro- and macroeconomics (and I'll include myself in that stereotype statement). So, if you think you're going to glean a mastery level of economic theory that allows you to predict a stock market shift or the future price of pork bellies - you can forget that.
If you want be smarter and more knowledgeable about economic conditions for the near-term future, you can probably put your faith in the law of large numbers and some semi-reliable information sources draw some pretty solid inferences and generalizations from existing information that will benefit you and your organization.
Posted by: Chris Dobyns | 12/19/2017 at 08:19 AM