“REDDEPPA NAIDU ABBAREDDY”

“ECON 6635-01”

“POMPEA COLLEGE OF BUSINESS”

“UNIVERSITY OF NEW HAVEN”

“Date: 12-13-2024”

INTRODUCTION

To gain insights into the functioning of the U.S. economy, we need to look at both national trends and local factors. In this analysis, we create a diffusion index that combines data on employment, industrial production, and consumer sentiment. This index is then compared with the Chicago Fed National Activity Diffusion Index (CFNAIDIFF). By doing this, we can better identify patterns of economic growth and contraction over time and gain meaningful insights into the overall health of the economy.

SELECTION OF DATA AND BUILDING THE DIFFUSION INDEX

The diffusion index identifies patterns of economic expansion and contraction by examining three key indicators: employment, industrial production, and housing starts. These indicators reflect labor market performance, industrial output, and construction trends, providing a comprehensive view of the economy’s overall direction.

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

EVALUATION OF U.S. DIFFUSION INDEX

The U.S. Economic Diffusion Index Over Time highlights key trends in economic expansion and contraction. The custom Diffusion Index (blue line) shows frequent short-term fluctuations, while the red smoothed line illustrates a broader long-term trend. Between 2010 and 2020, the index generally stayed above 50%, signaling economic growth. However, a gradual decline during this period indicated weakening momentum even before 2020. This trend shifted dramatically with the onset of the COVID-19 pandemic in March 2020, when the index dropped sharply below 0%, reflecting widespread economic disruption.

In the post-pandemic period from 2020 to 2025, the index recovered but remained below pre-pandemic levels. The final recorded value of -33.33% points to ongoing economic challenges and a slower recovery. This suggests that while some sectors rebounded, the overall economy struggled to regain its previous strength. The analysis underscores the pandemic’s significant impact and reveals the uneven nature of the recovery process, with lingering weaknesses affecting various aspects of economic activity.

EVALUATION OF THE CHICAGO ECONOMIC DIFFUSION INDEX

The Chicago Economic Diffusion Index (CFNAIDIFF) from 2010 to 2025 illustrates key trends and fluctuations in economic activity. Between 2010 and 2016, the index shows a steady decline, indicating a period marked by economic weakness or contraction. From 2016 to 2020, the index hovers around zero, reflecting stagnation or a modest recovery. Following the initial shock of the COVID-19 pandemic in 2020, the index experiences a slight uptick, indicating a temporary rebound. However, this recovery is short-lived, as post-2023, the index declines sharply, falling below zero and signaling renewed economic challenges or contraction.

The box-like red lines on the graph depict frequent shifts between expansion and contraction, highlighting the volatility and uncertainty of economic performance. Toward 2025, the widening confidence band suggests growing uncertainty about future economic conditions. The overall long-term trend points to persistent economic weakness, interrupted by occasional recoveries. This pattern underscores the importance of continuous monitoring to gain insights into evolving economic dynamics and to anticipate potential challenges.

COMPARISON OF STABILITY AND FLUCTUATION

The U.S. Diffusion Index demonstrates an overall positive trend, with an average value of 42.1 and moderate variability (SD = 52.5), suggesting steady national economic growth. In contrast, the Chicago Diffusion Index has a negative average of -2.9 and a higher variability (SD = 100.2), indicating frequent and sharp economic downturns. This comparison underscores the higher economic volatility observed at the regional level compared to the more stable national trend.

## [1] 0.0703

EVALUATION OF THE COMBINED U.S. AND CHICAGO DIFFUSION INDICES

The comparison between the custom Diffusion Index and the CFNAIDIFF provides valuable insights into how different indicators reflect economic trends. The custom Diffusion Index (blue line) shows sharp fluctuations, capturing the immediate effects of changes in employment, industrial production, and housing starts. In contrast, the CFNAIDIFF (red dashed line) follows a smoother path, representing a broader national outlook. The two indices align during key economic disruptions, such as the 2010-2012 period and the 2020 COVID-19 pandemic, demonstrating that both indices effectively track major shifts in economic activity.

Between 2015 and 2019, the custom Diffusion Index and CFNAIDIFF diverge, suggesting that the custom index is more responsive to sector-specific fluctuations. In contrast, the CFNAIDIFF reflects a broader aggregation of economic activities. The correlation coefficient of 0.306 indicates a moderate positive relationship, showing that while the indices tend to move in the same direction, the custom index captures more localized and short-term variations. The heightened volatility of the custom Diffusion Index underscores its sensitivity to specific sectors, whereas the CFNAIDIFF offers a more stable, high-level perspective on national trends. Combining both localized and national indicators provides a more comprehensive and nuanced understanding of the economy.

CORRELATION

The correlation coefficient of 0.0703 between the U.S. Economic Diffusion Index and the Chicago Diffusion Index reflects a very weak positive correlation. This low value implies that there is minimal linear relationship between the two indices. In other words, changes in the national (U.S.) economic diffusion index and the regional (Chicago) diffusion index do not consistently or predictably align with each other.

RECENT ECONOMIC PERSPECTIVES

  • Slower Growth: The economy is exhibiting signs of slower growth or slight contraction.
  • Industry-Specific Challenges: Declines in employment, industrial production, and housing are driving this slowdown.
  • Continued Instability: Economic volatility persists, fueled by inflation, elevated interest rates, and global challenges.
  • Regional Decline: While national trends seem stable, some regions and sectors face notable challenges. The indices indicate a fragile economy, making it essential to monitor key indicators to gauge whether conditions stabilize or deteriorate further.

CONCLUSION

This report compared diffusion indices for three key economic variables in the U.S. and Chicago from January 2010 to October 2024. Both indices showed economic ups and downs, including a sharp drop during the COVID-19 pandemic. The Chicago Index was more volatile than the U.S. Index, indicating regional trends can differ from national ones. To fully understand the economy, it’s important to consider both regional and national factors.