Industrial Production & Capacity Utilization

Web address: www.federalreserve.gov/releases/g17/current

Industrial Production (IP) Index:IP covers nearly everything produced in the U.S. (20% of the economy) for manufacturing (82%), mining (8%), electric utilities (10%) and gas

industries.

Does not include output from agriculture, construction, transportation, communications, and service industries.

Measures changes in the volume of goods produced (does not take price into account)

IP corresponds to real GDP (close relationship between IP and GDP)

Manufacturing is most cyclically sensitive part of economy, follows the ups and downs of the business cycle.

Manufacturing activity is highly sensitive to changes in interest rates and aggregate demand.

Good forecaster of manufacturing employment, average hourly earnings and personal income

IP data has 2 formats:

Supply Side: Output by industry (manufacturing, mining, utility)

Demand Side: Type of product, (consumer/business/intermediate goods and materials)

Real GDP growth estimator = 3-month IP/IP

Nominal GDP/Factory Sales/Manufacturing Revenues Growth estimator =

(3-month IP/IP) x (3-month CPI/CPI)

Capacity Utilization (CU):Present production divided by maximum potential production capacity

81% long-run average

Measure of spare capacity/slack at factories, mines, utilities.

Leading indicator of business investment spending and inflation pressures.

High CU => rising investment spending and hiring, shortage of vendor parts, higher prices

Low CU => low investment spending and hiring, surplus of vendor parts, lower prices.

Follows the ups and downs of the business cycle.

CU = 82-85% => production bottlenecks => rising producer prices

--------------------------------------------------------------------------------------------------------------------------

High IP/CU => fast growing economy => rising profits => rising stock prices

=> production bottlenecks => rising inflation => rising interest rates => falling bond demand

=> fast growing economy => rising demand for dollar => rising exchange rate

Industrial Production Index(2007 = 100)

-16%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

55

60

65

70

75

80

85

90

95

100

105

110

115

120

Recession IP Y/Y Growth IP Index

Capacity Utilization(Total and Manufacturing)

62

64

66

68

70

72

74

76

78

80

82

84

86

88

90

82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

per

cen

t

62

64

66

68

70

72

74

76

78

80

82

84

86

88

90

Recession

Total

Manufacturing

Full capacity = 82-84%

Liquidity Preference Analysis

Derivation of Demand Curve1. Keynes assumed money has i = 02. As i , relative RE on money (opportunity cost of money )

Md 3. Demand curve for money has usual downward slope

4. QDM = f(i; Y, P) - + +

Income Effect: Y => QDM at each i (DM )Y =>W =>DM as medium of exchange and store of value

Price Level Effect: P =>QDM at each i (DM )People care about purchasing power of money,

real money balances = X = M/P

M x V = P x Y

M/M + V/V = P/P + Y/Y

P/PM/M + V/V - Y/Y

If V/V = 0,

Then P/PM/M - Y/Y

If M/M > Y/Y

Then P/P > 0

If M/M = Y/Y

Then P/P = 0

Milton Friedman: “Inflation is everywhere and always a monetary phenomenon”

Equation of Exchange(identity)

Velocity of Money = V(rate of money turnover)(link between M & PY)

Deposit Interest Ratesversus Fed Funds

0

1

2

3

4

5

6

7

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

Source: CUNA's E&S

Percen

t

Fed Funds Regular SharesMMAs CDs

Money Demand Growth(Checking, Savings, MMA)

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

Monthly Growth

0.0

2.0

4.0

6.0

8.0

Interest Rate

Recession Money Growth Fed Funds Rate

Money Demand (Savings) Curve

0

0.5

1

1.5

2

2.5

3

3.5

4

-1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5%

Monthly Savings Balance Growth

CD

/Sav

ings

Rat

e D

iffe

rent

ial

929394

95

9697

99

98

0302

0100

04

05

06

07

CD Growth

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

Source: CUNA's E&S

Monthly Growth

0.0

2.0

4.0

6.0

8.0

Interest Rate

Recession CD Growth Fed Funds Rate

Loanable Funds (CD) Supply Curve

0

0.5

1

1.5

2

2.5

3

3.5

4

-3% -2% -1% 0% 1% 2% 3% 4% 5%

Monthly CD Balance Growth

CD

/Sav

ings

Rat

e D

iffe

rent

ial

92 93 94

95

9697

99

98

0302

01

00

04

05

06

07

11

GDP Output Gap vs.Federal Funds Rate

-8%

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

85 88 91 94 97 00 03 06 09 12

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

Recession

Output Gap (LHS)

Federal Funds Rate (RHS)

Source: CBO & Federal Reserve.

Consumer Price Index 1970 to Present

5.6

3.33.4

8.7

12.3

6.9

4.9

6.7

9.0

12.5

8.9

3.83.84.04.44.44.7

6.1

3.12.92.72.72.5

3.3

1.71.6

2.6

3.4

1.6

2.41.9

3.33.5

2.5

4.1

-0.1

2.8

1.4

3.0

1.7

3.8

1.1

13.3

2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5 2 .5

-1

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12

Hoarding money => deflationAusterity => stagnation/deflationDeflation => rising purchase power of dollarDeflation => lower wages => rising debt burden

Deflation leads to:•Households postpone spending•Rising real interest rates•Rising debt burdens

2.5% Target

Inflation (CPI)(year over year % growth)

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

HeadlineCore (excludes food and energy)

Taylor rule A rule developed by John Taylor that links the Fed’s target for the federal funds rate to economic variables.

Federal funds target rate = Current inflation rate + Real equilibrium federal funds rate + (1/2) x Inflation gap + (1/2) x Output gap

Inflation targeting Conducting monetary policy so as to commit the central bank to achieving a publicly announced level of inflation.

Consumer Confidence/Sentiment Index(Real Time Measures of Consumers Attitudes on Economy, Personal Finance, and Future Spending)

Web: http://www.conference-board.org/economics/consumerConfidence.cfm

Web: http://www.sca.isr.umich.edu/main.phpMinor revisions

Happy consumers are good for business so index is useful for predicting consumer spending. Unfortunately, the relationship between confidence index and spending is not a close one.

Difficult to predict how humans will behave. Sales are the best method of measuring consumer confidence.

A six month moving average of confidence is a better indicator of future household outlays.

Index is important during economic turning points. Better at forecasting recessions than recoveries.

Consumer confidence Index polls 5,000 new households, the survey has 5 questions with emphasis on labor market conditions - which can lag the economy

Consumer Sentiment Index polls 500 new and continuing households (the rotating interview strategy is 60% new and 40% second time interviews => less erratic index), 50 questions with emphasis on financial and personal income expectations which is a driving force behind consumer spending => better leading indicator.

------------------------------------------------------------------------------------------------------------------------------------------------

Market Analysis:Bonds: Confidence => borrowing/spending => P/P => DBonds => iBonds

Stocks: Confidence => borrowing/spending => Y/Y => profits => PStocks

Dollar: Confidence => borrowing/spending => Y/Y => iBonds => dollar

Consumer Confidence & Sentiment Index

0

10

20

30

40

50

60

70

80

90

100

110

120

130

140

150

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 140

10

20

30

40

50

60

70

80

90

100

110

120

130

140

150

Recession Confidence Sentiment

Source: Conference Board & University of Michigan