What is Indexing?
Indexing refers to using a benchmark to track or measure something. This benchmark could be an index number, which is a statistical measure that reflects changes in a particular economic indicator, like inflation or stock market performance. Investors also use indexing as a passive investment strategy.
How Indexing Works
In economics, indexing revolves around using a benchmark to understand and adjust for economic changes. There are two main applications:
Economic Indexes, practical and efficient tools, are broad metrics that capture various economic data points into a single score. They act as a snapshot of a specific economic aspect, like the Consumer Price Index (CPI) which tracks inflation by measuring price changes of a basket of goods and services. Other examples include indexes for industrial production, employment, or leading economic indicators. By monitoring these indexes, economists and policymakers can estimate the health of the economy and identify trends, empowering them with valuable insights.
Indexing can also refer to automatic adjustments tied to an economic index, providing a sense of reliability and stability. A common example is cost-of-living adjustments (COLA) for wages or social security benefits. These are automatically increased based on inflation (tracked by an index like CPI) to maintain purchasing power. Similarly, some contracts may have interest rates or other terms indexed to an economic indicator, ensuring they stay relevant in a changing economic environment.
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