The Dismal Boom

There is a fundamental assumption behind any purchasing manager index, or PMI. These are often but not always normalized to the number 50. That’s done simply for comparison purposes and the ease of understanding in the general public. That level at least in the literature and in theory is supposed to easily and clearly define the difference between growth and contraction.

But is every 50 the same? That’s ultimately at issue in 2018. The assumption is that a 50 is a 50 and that they are comparable on an apples to apples basis. Behind that postulation is symmetry.

We can illustrate the process with some stylized thought experiments. IHS Markit, for example, asks thousands of vetted corporate executives in the second half of each and every month whether overall and in particular pieces of their business has it improved, deteriorated, or stayed the same compared to the previous month. We can think, then, of a 50 for the index or subindex as something like 33% saying improved, 33% saying deteriorated, and the last third claiming it’s the same.

It’s intuitive that if from that position the following month 40% are in the improved column because 7% moved out of deteriorated, leaving 26% with that view and still 33% at “the same”, the headline index moving up to 53 would be consistent with actual economic improvement. That part is uncontroversial.

What’s left out of every calculation is the degree to which something is changing. If we move from 33/33/33 to something like 25/50/25, that’s entirely consistent with the index plunging below 50 and the economy most likely in some state of downturn. And if a few months or a year later the survey results go back to 33/33/33, then the headlines’ return to 50 would be consistent as if things are stabilizing. If it then goes 40/26/33, does that necessarily mean growth has been restored?

The reason these surveys aren’t more in-depth is this implicit idea that when growth is resumed it is resumed at the same general trend as before (symmetry). It’s another one of those mathematical shortcuts (the fewer the variables the better) that when first designed appeared to be trivial because economic history, particularly postwar economic history, had always obeyed symmetry (leading Milton Friedman to confidently assert his “plucking model” in 1993).