Measuring Economic Health

Introduction to Money

Economists keep their fingers on the pulse of the economy at all times, determined to cure what ails it. Thousands of experts - and countless more interested amateurs - watch the economy all the times. Whether the economy is doing good or bad, individuals and organizations keep watching it.

The Index of Leading Economic Indicators is released every month by The Conference Board, a business research group. Generally, three consecutive rises in the Index are considered  a sign that the economy is growing - and three drops, a sign of decline and potential recession.

Ten leading indicators are averaged to produce the Index, with some carrying more weight than others. Taken together, they are designed to predict short-term economic conditions. Among the indicators are the spread between the 10-year treasury and the federal funds rate, the M2 (described below) money supply, the S&P 500-stock index and the four described below.

Unemployment Figures - New unemployment claims for state unemployment insurance give a sense of the number of people losing their jobs. A falling number is a sign the economy is growing. The flip side of low unemployment, however, is the fear of increasing inflation.

Durable Goods - A backlog of orders for a wide range of manufactured products, from machinery to transportation equipment, signals increasing demand that will keep the economy expanding.

Housing Starts - The number of housing permits being issued is a measure of economic health. A growing economy typically generates increased demand for new housing.

New Factory Orders - Rising orders reported by manufacturers for consumer goods and materials affirms confidence in the economy and suggests continued growth.

Definitions
Economists and policy makers keep careful track of the public money supply using measures called M1, M2, M3 and L.

The three Ms are monetary aggregates, or ways to group assets that people use in roughly the same way.

M1 or narrow money - includes all money in immediately spendable forms: cash and money in checking accounts.

M2 or broad money - includes M1 but adds savings and money in small time deposits (like CDs). The latter cannot be spent directly but can be converted easily to cash.

M3 is the broadest measure of the money supply. It includes all of M1 and M2, plus the assets and liabilities of financial institutions, including long-term deposits, which can't be easily converted into spendable forms.

L is a measure of other highly liquid assets, and adds a number of short-term bonds, commercial paper and savings bonds, for example, to M3.