Understanding Diffusion Indexes: Insights and Applications

Diffusion indexes (DIs) are statistics that offer timely glimpses into the state of the economy.1 Frequently constructed from responses to qualitative surveys, these indexes provide a snapshot of the direction and breadth of change in key economic variables. Typically, these surveys ask participants to report whether a specific variable — such as employment or business conditions — improved, declined or remained unchanged compared to a previous period. The responses are then aggregated to calculate a DI, often expressed as a percentage. A DI above a certain threshold — which varies depending on the weighting method — typically signifies an expansionary scenario, while a DI below the threshold indicates a contractionary one. The appeal of DIs generally lies in their timeliness, simplicity and relatively low cost of participation. They offer insights into economic conditions more rapidly than traditional economic data releases, making them valuable tools for policymakers, analysts and market participants.