Transcript Economics, by R. Glenn Hubbard and Anthony Patrick O`Brien

Institute for Supply Management, ISM
Manufacturing Index
(Measure of Manufacturing Activity)
Web: http://www.ism.ws/ISMReport/index.cfm
No monthly revisions,…but reassessments of seasonal adjustment factors in January
ISM is a private, Tempe, Arizona based group that represents corporate purchasing managers – procure production materials and supplies to make
products – in the goods-producing industry – highly sensitive to the ebb and flow overall economic activity.
Survey results come out the first business day of every month (very timely)
ISM surveys 400 companies, representing 20 industries, to assess if activity is rising, falling or unchanged in the following fields:
New Orders (30%) - by purchasing agents
Production (25%) - manufacturing output
Employment (20%) – hiring by the company
Supplier deliveries/Vendor performance (15%) – speed of supplier delivery
Inventories (10%) – the rate of liquidating manufacturers’ inventories
Purchasing Managers Index (PMI) is a compilation of the 5 components listed above weighted by the given percentages. The PMI is a diffusion
index, showing changes in month to month activity, but not actual levels of production.
Component number = % reporting rising + ½ % reporting no change
PMI is an effective gauge of business cycle turning points
If PMI > 60 for a sustainable period with the economy operating above potential => Fed raising interest rates
If PMI > 50 => expanding manufacturing sector, with every additional full index point adding 0.3 percentage points of economic growth over next 12
months.
If PMI = 50 => no change in manufacturing activity, with DY/Y = 2.5%
If 43 < PMI < 50 => contracting manufacturing sector, but economy may still be growing
If PMI < 43 on a sustained basis => recession. Expect Fed to lower interest rates.
ISM Non-Manufacturing Business Activity Index – measures service sector business activity (non-manufacturing industries represent 80% of
economy)
Service sector (medical care, communication, financial, consulting, entertainment, legal, insurance, lodging) is not as cyclical as manufacturing
A reading of 50 shows the same percentage of managers reporting higher activity as lower activity
Index > 50 indicates growth in service industry
Index < 50 indicates contraction in service industry
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Market Analysis:
Bonds: PMI > 50 and Y > YPot =>  DP/P =>  DBonds =>  iBonds
Stocks: PMI > 50 and Y < YPot =>  DY/Y =>  profits =>  PStocks
Dollar: PMI < 50 =>  DY/Y =>  iBonds =>  dollar
ISM Purchasing Managers Index
(SA)
70
70
65
65
60
60
55
55
50
50
45
45
40
40
Recession
35
Manufacturing Activity
35
No Change in Manufacturing Activity
30
30
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Annual % Change in U.S. Economic Output
(Real GDP - Chainweighted 2005$)
6%
4.8%
5%
4.5% 4.4%
4.1%
4.1%
3.8%
4%
3.7%
3.5%
3.4%
3.1%
3%
2%
3.1%
2.9%
3.1%
2.9%
2.5%
2.5%
1.8%
1.8%
3.0%
2.7%
1.9%
1.7%
1.1%
1%
0%
-1%
-0.5%
-0.3%
-2%
-3%
-3.5%
-4%
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Source: Department of Commerce.
Keynesian ISLM Model
Model Explains 2 things:
1. Determination of Output, Y
2. Why Ye < YFE
Aggregate Expenditure Model: focuses on the relationship between
spending (AE) and production (Y) assuming fixed price level.
(nominal = real) => DY without D P
AE = C + I + G + X-M
Macroeconomic Equilibrium
AE = Y
(no D in inventories => no D in production rate)
Assume no organic DY/Y
%D(Y/L) = 0
DL/L = 0
Domestic Production, GDP, Y
Foreign Production, M
Macro Equilibrium
Y = AE
Inventory
AE = C + I + G + X
Equilibrium Condition
Inflow = Outflow
QS = QD
The Circular Flow Diagram
AE = C+I+G+X-M
Recent U.S. Economic Performance
Housing Market Contraction
AE = Y
AEE06
AE05
Series of induced C
Multiplier Effect
AE06
DY
DY
DC
DC
Inventory =>
Homebuilders’ Y
D Autonomous Spending
•Low pent up demand
•Fewer investors
•Tighter underwriting
•Higher interest rates
•Expected lower future
home prices
Y08
Y05Pot
Y06
Recession
Optimism => Firm’s  production
Unplanned
housing
inventory
accumulation
Y
Output
Income
Falling
Home Prices
Negative Downward Spiral
Falling Household
Wealth
Falling Household
Spending
 HELOC
•Salaries
•Commissions
•Bonuses
•Tips
Lower income
•Self-reinforcing spiral
•Feedback Loop
•Multiplier Effect
•Sum of an
Infinite Geometric Series
Increase unemployment
Rising Inventories
Lower Factory
Production
Real Personal Consumption Expenditures
(% chg from quarter one year ago)
16
16
Total average growth = 3.3%
13 . 73
(Furniture, appliances, autos) average growth = 6.0% (14%)
(Food, clothing, energy) average growth = 3.4% (29%)
12
10 . 78
11. 0 4
8 .8 7
7. 8 3
8
3 .2 4
2 . 52
4
7. 3
6 .4
5. 55. 1
4 .5
6 .6
2 .4 3
1. 2 2
0 . 77
12
8 .3 5
6 . 73
5. 53
5. 9 4
5. 2 5
4 . 72
Services average growth = 2.8% (57%)
(Housing, transportation, medical care, recreation)
10
8
6 .3
5. 4
4 . 44 . 64 . 6
3 .6
4
4
2 . 1 2 . 32 . 3
0 .8
0
0
0 0 Q1
0 1Q 1
0 2 Q1
0 3 Q1
0 4 Q1
0 5Q 1
0 6 Q1
0 7Q 1
0 8 Q1
- 1. 2
0 9 Q1
- 1. 5
-4
-4
- 5. 4
-8
-8
- 8 .-98 . 8
-12
- 11. 8
-16
-12
-16
Durable
Nondurable
Total
Services
D Autonomous Expenditure (Intercept) => multiple D Y
Consumption:
1.
2.
3.
4.
Household Wealth
 PAssets =>  Wealth =>  C
Expected Future Income  YEt+1 =>  Ct
Price level
 P =>  W/P (real wealth) =>  C
Interest rate
r =>cost of borrowing => Cdurables
Investment:
1.
2.
3.
4.
PE(t+1)
Cost of Capital
Taxes
Cash flow
Animal Spirits, business confidence
Real long-term interest rates
Retained earnings, profits
Net Exports:
1. PLU.S./PLROW
2. (DY/Y)U.S. / (DY/Y)ROW
3. Exchange rate
 PL U.S. =>  NX
 (YU.S. / YROW ) =>  NX
 (e/$ ) =>  NX
Current Account Balance
$25,000
$0
-$25,000
-$50,000
-$75,000
-$100,000
-$125,000
-$150,000
-$175,000
-$200,000
-$225,000
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
ISM-Chicago
Business Barometer Index (BBI)
(Measure of Manufacturing Activity in the Midwest Region)
Web: https://www.ism-chicago.org/index.cfm?
Reassessments of seasonal adjustment factors in January
The Chicago chapter is an affiliate (one of ten local ISM chapters) of the Institute for Supply Management, (ISM). The Chicago group publishes their
survey one business day before the national ISM manufacturing number is released.
The Chicago Business Barometer Index, BBI, moves in same direction as the national ISM numbers about 60% of the time and has a 90% correlation
regarding their magnitude change. But for financial market traders, the direction is more relevant than the level of change.
Survey region covers the industrial heartland of Illinois, Indiana and Michigan, which contains a large part of the auto and auto parts sectors. The
Federal Reserve monitors the Chicago NAPM report to study conditions in the manufacturing sector and check for signs of production
imbalances.
ISM-Chicago, queries 200 purchasing managers regarding their business activity to assess if activity is rising, falling or unchanged.
Survey results are compiled into a diffusion index, (BBI), based on a weighted average of 5 subcomponent indexes:
New Orders (35% weight) - by purchasing agents
Production (25% weight) - manufacturing output
Employment (10% weight) – hiring by the company
Supplier deliveries/Vendor performance (15% weight) – speed of supplier delivery
Order backlogs (15% weight)
The Business Barometer Index (BBI) is a compilation of the 5 components listed above weighted by the given percentages. The BBI is a diffusion
index, showing changes in month to month activity, but not actual levels of production.
Component number = % reporting rising + ½ % reporting no change
The difference between % reporting rising and % reporting falling:
( % -  %) = (Index - 50) x 2. (Recall, 100% = % + no chg % + % and Index = % + ½ (no chg %)
ISM-Chicago is an effective gauge of business cycle turning points:
If BBI > 50 indicates expansion in business activity.
If BBI < 50 indicates contraction in business activity.
Data for the Chicago BBI is not the same data used to calculate the National ISM Index.
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Market Analysis:
Bonds: Unexpected  BBI =>  DY/Y =>  DP/P =>  DBonds =>  iBonds
Stocks: Unexpected  BBI =>  DY/Y =>  profits =>  PStocks
However if Y > YPot and  BBI => expected  interest rates by Fed. Res =>  PStocks
Dollar:  BBI =>  DY/Y =>  profits &  interest rates =>  Ddollar =>  $
ISM Chicago
(Diffusion Index, SA)
75
75
70
70
65
65
60
60
55
55
50
50
45
45
40
40
Recession
Chicago Index
35
35
No Change in Manufacturing Activity
30
30
00
01
02
03
04
05
06
07
08
09
10
11
12
13