Wednesday, June 16, 2010

Industrial Production and Capacity Utilization

You may be wondering: What is Industrial Production and Capacity Utilization?  The Industrial Production series measures changes in the volume of goods produced.  This series is important because manufacturing activity is highly sensitive to interest rates and demand, so it closely parallels shifts in the overall economy.  Also it doesn't take the price of these products into consideration so there is no distortion in the numbers from inflation.  Furthermore since this makes it a pretty nice measure of output it correlates reasonably well with real GDP (Real GDP is nominal GDP adjusted for inflation).

To understand the meaning of capacity utilization think about a firm that has the capacity to manufacture 100 airplanes a year but is currently only producing 70 airplanes- it has an operating capacity utilization rate of 70%.  Now just imagine this for the whole economy and you get a sense of what it is.  The Federal Reserve's definition of capacity is based on what is considered the normal operating time for each industry. 

The current capacity utilization rate (for May) is 74.7 and at this rate there is not much reason for firms to hire additional workers (but may lead to extended average hours worked and overtime pay) because there is currently not enough demand to purchase what can easily be produced.  On a positive (and deflationary note) this capacity utilization rate is about 10% lower then where it needs to be for inflationary pressures to flare up.  The good news is that we are indeed producing more as the capacity utilization rate has been edging upward over the past few months. 

For the most recent report:

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