Capacity Utilization and U.S. Inflation

Policymakers and economic analysts have recently been concerned about potential inflationary pressures in the U.S. economy. Various economic statistics show the amount of unused productive resources has been diminishing. For example, the civilian unemployment rate has decreased and the capacity utilization rate of the nation’s factories has risen. If real output grows rapidly in the future, the competition for scarce productive resources could put upward pressure on wages and other production costs and ultimately could raise consumer price inflation. Some analysts have challenged the view that productive resources are becoming so scarce that higher inflation is a danger. This challenge partly turns on whether the capacity utilization rate, which measures the percent of manufacturing capacity currently in use, is a reliable indicator of inflationary pressures. Most economic forecasters believe inflationary pressures build after capacity utilization rises above a certain level. Some analysts have claimed, however, this historical relationship is no longer valid because the economy has become more open, allowing imported goods to relieve any shortage of domestic capacity. Some analysts also have argued that manufacturing capacity shortages will not be a problem in the foreseeable future because of rapid technological progress and strong business investment. This article examines whether the capacity utilization rate for the manufacturing sector is still a reliable indicator of inflationary pressures. The first section describes the capacity utilization rate and summarizes recent arguments about whether the relationship between capacity utilization and inflation has changed. The second section presents empirical evidence testing whether the economy can now operate at a higher utilization rate than in the past without the inflation rate rising. The article concludes that the historical relationship between capacity utilization and inflation still holds, indicating the capacity utilization rate remains a reliable indicator of inflationary pressures.