-ECON 6635-01

-Pompea College of Business

-University of New Haven

-Jeevan Reddy Mallepally

0.0.1 Introduction

Understanding the complexities of the U.S. economy requires a comprehensive view that captures both national trends and localized economic signals. In this analysis, we construct a diffusion index using key economic indicators: employment, industrial production, and housing starts. This custom index serves as a barometer of economic expansion and contraction. By comparing it to the widely recognized Chicago Fed National Activity Diffusion Index (CFNAIDIFF), we aim to uncover meaningful patterns and divergences that offer insights into the broader economic environment and sector-specific dynamics over time

0.0.2 Data selection and Diffusion Index Construction.

The diffusion index captures patterns of economic growth and decline by analyzing three key indicators: employment, industrial production, and housing starts. These variables provide a broad perspective on labor market strength, industrial output, and construction activity, offering valuable insights into the overall economic trajectory.

## [1] "PAYEMS"    "INDPRO"    "HOUST"     "CFNAIDIFF"

0.0.3 Analysis of USA Diffusion Index

The U.S. Economic Diffusion Index Over Time reveals notable trends in economic expansion and contraction. The blue line, representing the custom Diffusion Index, shows frequent fluctuations, while the red smoother line captures the long-term trend, which remains mostly stable but exhibits a gradual decline. During the pre-pandemic period (2010-2020), the Diffusion Index hovered above 50%, indicating economic expansion, though a slow decline suggested weakening momentum leading up to 2020. The onset of the COVID-19 pandemic in March 2020 led to a sharp drop in the index, which fell well below 0%, reflecting widespread economic disruption. In the post-pandemic period (2020-2025), the index rebounded but settled at a lower level compared to the pre-pandemic period, with the final value of -33.33% indicating ongoing economic challenges and a weaker recovery. This analysis underscores the significant economic shock caused by the pandemic and highlights the uneven nature of the subsequent recovery.

0.0.4 Analysis of Chicago Economic Diffusion Index

The Chicago Economic Diffusion Index (CFNAIDIFF) graph from 2010 to 2025 reveals significant trends and fluctuations in economic activity. From 2010 to 2016, the index shows a steady decline, indicating a period of economic weakness or contraction. Between 2016 and 2020, the index fluctuates around zero, suggesting stagnation or mild recovery. Around 2020, the index rises slightly, reflecting a temporary rebound after the initial shock of the COVID-19 pandemic. However, post-2023, the index experiences a sharp decline, falling well below zero, indicating renewed economic challenges or contraction. The box-like red lines illustrate frequent shifts between expansion and contraction, reflecting volatility and uncertainty in economic performance. The widening confidence band toward 2025 highlights increasing uncertainty. Overall, the long-term trend indicates persistent economic weakness, with intermittent recoveries, emphasizing the need for continuous monitoring to understand future economic dynamics.

0.0.5 Stability and Volatility Compared

The US Diffusion Index shows an overall positive trend with a mean of 42.1 and moderate variability (SD = 52.5), indicating relatively stable national economic expansion. In contrast, the Chicago Diffusion Index has a negative mean of -2.9 and high variability (SD = 100.2), reflecting frequent and severe economic contractions. This highlights greater economic volatility at the regional level compared to the national trend.

## [1] 0.0703

0.0.6 Analysis Of The Combined US & Chicago Diffusion Indices

The combined analysis of the USA Economic Diffusion Index and the Chicago Diffusion Index (CFNAIDIFF) reveals key insights into national and regional trends from 2010 to 2025. The USA Diffusion Index (blue) shows frequent fluctuations, reflecting volatility in employment, industrial production, and housing starts, with a general trend toward economic expansion. In contrast, the Chicago Diffusion Index (red) displays a more consistent downward trend, particularly between 2010 and 2016, indicating regional economic weakness.

A brief recovery in 2020 is followed by a sharp decline after 2023, highlighting renewed challenges in the Chicago region. The divergence between the two indices underscores the resilience of national trends compared to localized contractions. The moderate correlation between them suggests shared economic influences, though regional factors drive unique patterns. This analysis emphasizes the need to monitor both national and regional indicators for a comprehensive economic outlook, especially given ongoing uncertainties like inflation and sector-specific challenges.

0.0.7 Coorelation

The correlation coefficient of 0.0703 between the USA Economic Diffusion Index and the Chicago Diffusion Index indicates a very weak positive correlation. This low value suggests that there is little to no linear relationship between the two indices. In other words, the changes in the national (USA) economic diffusion index and the regional (Chicago) diffusion index do not move together in a consistent or predictable manner.

0.0.8 Current Economic Insights

  • Slowing Growth: The economy is showing signs of slowing growth or mild contraction.
  • Sectoral Challenges: Weaknesses in employment, industrial production, and housing are contributing to this slowdown.
  • Ongoing Uncertainty: Economic volatility remains, driven by inflation, high interest rates, and global issues.
  • Localized Weakness: While national trends appear stable, certain regions and sectors are experiencing more significant challenges. -Overall, the indices suggest that the economy is in a fragile state, with potential risks of further slowdown if current challenges persist. Monitoring key economic indicators in the coming months will be crucial to understanding whether the economy stabilizes or continues to weaken.

0.0.9 Conclusion

This report constructed and compared the diffusion indices for 3 key economic variables in the United States and the Chicago Index. By examining these indices, we were able to observe periods of both positive and negative economic movements during the period of January 2010 to October 2024. Both diffusion indices exhibited significant fluctuations, including a marked downturn caused by the COVID-19 pandemic. However the Chicago Index exhibited more volatility than the U.S Index demonstrating that in order to fully understand the health of the economy you need to look at both regional and national trends as they can be impacted by other varying factors.