Data on Production and Producer Prices Will Not Change Fed Policy
Data on industrial production, capacity utilization, and the producer price index were released today. Turning first to the price data, the seasonally adjusted data for the producer price index rose 0.3% on an annual basis, but when food and energy prices are removed to get the core measure of inflation, the measure fell by 0.6%. Thus, these data show no evidence of an inflation problem due to rising input costs (the core measure is important because it provides a better forecast of inflation in the future than the forecast based upon actual, non-core inflation).
As for the measures of output, industrial production and capacity utilization data showed improvement over last month with industrial production rising 0.1% on an annualized basis and capacity utilization increasing 0.2 percentage points (from 70.5% to 70.7% month to month), but the rate of change is not as fast as we'd like to see. The following graphs shows these two series:
Industrial Production
Capacity Utilization
These graphs bring up three issues. First, the increase in industrial production was welcome, but it was also smaller than we anticipated, and certainly smaller than we hoped for (same for capacity utilization). This has implications for the second issue, which is how fast industrial production will recover. Will it crawl slowly back to trend, or will it return to trend fairly quickly? The indications from today's data are that it will be a slow recovery rather than a rapid return to the long-run trend.
Finally, what level of capacity utilization will be consistent with full employment in the future? As shown in the graph, prior to the most recent recession full employment was associated with the economy running at about 85% of capacity, while more recently full employment has been at around 81% of capacity. Is 81% the right figure for the future, or will the full employment level of capacity utilization be higher or lower than in the recent past (I expect it will be about the same)? This is important because if the Fed shoots at too high of a target, i.e. tries to achieve 85% of capacity when 80% is full employment, it could be inflationary (the Fed thinks more in terms of employment and output growth when it answers these questions, see here for a discussion of employment, but capacity utilization can be used for the same purposes).
What does this mean for policy? The lack of inflation pressure combined with a sluggish recovery are consistent with the outlook for the economy given yesterday by Federal Reserve Chair Ben Bernanke, and reinforce his message that the Fed sees boosting the economy rather than fighting inflation as its primary mission right now. Thus, we should expect the Fed to continue its low interest rate policy for the foreseeable future.
