What Is PMI in Economics? A Key Economic Indicator

The Purchasing Managers’ Index (PMI) serves as a key economic indicator, offering valuable insights into the health of both the manufacturing and services sectors. Developed by the Institute for Supply Management (ISM) in the United States, similar indices are now tracked globally. The PMI provides a timely snapshot of prevailing business conditions.

Components of the PMI

The PMI is a composite index built upon survey responses from purchasing managers, encompassing five components:
New Orders: Measure the volume of new purchase orders received, indicating future demand for goods and services.
Production: Tracks output levels within the surveyed sector, reflecting current operational activity.
Employment: Gauges changes in the workforce, signaling hiring or layoff trends within companies.
Supplier Deliveries: Assesses the speed at which suppliers fulfill orders; slower deliveries can imply increased demand or supply chain pressures.
Inventories: Monitor the levels of raw materials and finished goods held by businesses, providing insight into supply-demand balance.

Calculating the PMI

The PMI is calculated through a survey process where purchasing managers are asked whether specific business activities have improved, remained unchanged, or deteriorated compared to the previous month. This survey data is then transformed into a diffusion index.

For each component, a response indicating “better” is assigned a weight of 1.0, “same” is given 0.5, and “worse” receives 0.0. These weighted percentages are summed for each component. The overall PMI is then derived by combining these five component indices, each given an equal weighting of 20%. This methodology results in a single index number that summarizes the direction and magnitude of change.

Understanding PMI Readings

Interpreting the final PMI number revolves around the 50-point threshold. A PMI reading above 50 indicates expansion within the surveyed sector. Conversely, a reading below 50 signals contraction. A reading exactly at 50 suggests no change from the previous month.

The distance of the PMI reading from the 50-point mark indicates the strength or weakness of the expansion or contraction. For instance, a PMI of 58 suggests stronger growth than a reading of 51. Month-over-month changes in the PMI can also signal acceleration or deceleration in economic activity.

Why the PMI Matters

The PMI is considered a leading economic indicator, often providing early signals of shifts in economic trends before they are evident in other data. Its forward-looking nature, particularly through components like new orders, allows it to anticipate changes in broader economic measures such as Gross Domestic Product (GDP), employment figures, and inflation. The data is released early each month, making it a timely source of information.

Economists use PMI data for forecasting economic growth and identifying potential turning points in the business cycle. Investors monitor the PMI to gauge market sentiment, as strong readings can indicate a favorable environment for corporate earnings. Policymakers, including central banks and governments, rely on PMI reports to assess the effectiveness of their economic strategies and adjust fiscal or monetary policies accordingly. The PMI is a widely watched and influential economic metric.