Wednesday, September 15, 2010

Industrial production continues to recover


Industrial production in the U.S. rose modestly in August, about in line with expectations. Production is up at an annualized rate of 6% in the past six months, and has rebounded 9% from the lows of June 2009. As the top chart shows, industrial production has also rebounded all over the world since early last year, with the most notable rebound occurring in Japan.


But as this next chart shows, capacity utilization rates remain unusually low, so we'll need to see a lot more in the way of rising industrial production before the economy returns to anything that might be termed "healthy." Still, we are making progress and that is the most important thing.


In this last chart, I've added the real Federal funds rate to the chart of capacity utilization. The Fed has believed for a long time that inflation is the by-product of a very strong economy, so it is not surprising to see the strong correlation between capacity utilization and the real funds rate. When capacity utilization rates are high, the Fed sees this as a good indication that "resource slack" is very low, and thus inflation risk is high, so it tightens by raising the funds rate relative to inflation. By the same token, low utilization rates reflect a lot of idle capacity and resource slack, and that means inflation risk is low, so easier monetary policy conditions are called for. The unprecedented degree of resource slack we've experienced in this recession has given rise to the widespread concern that deflation risk is high. I don't agree with that line of reasoning (inflation is a monetary phenomenon that has nothing to do with the strength of the economy), but that's what drives the Fed so we need to pay attention. In any event, the degree of slack is declining fairly rapidly, so that means that deflation concerns at the Fed should also be declining rapidly.

Interestingly, the last chart suggests that if capacity utilization rates continue to rise, then the Fed might end up raising rates a lot sooner than the market currently expects. Fed funds futures currently show almost no chance of a tightening until next summer at the earliest. I for one would be very happy to see higher rates, and for a number of reasons. For one, it would send a positive message that things were improving. Two, higher interest rates are a net benefit to households, since the average household has a lot more floating rate assets (e.g., money market funds and bank CDs) than floating rate debt (e.g., adjustable rate mortgages). Three, a tighter Fed would provide much-needed support to the dollar, which is near the bottom end of its historical valuation range these days. A strong dollar would in turn foster more investment (foreign investors are much more likely to invest here if they believe the dollar will retain its value).

5 comments:

brodero said...

Inside the industrial production
numbers,,,

Industrial production for Business equipment was up .7 following last months number of 1.0%...year over year this number
is up 9.9%... The importance of this is that this number mirrors
closely the equipment and software-business spending component of GDP.
In turn the business spending component in the past has mirrored payroll growth

Benjamin said...

Scott:
Japan has tried the strong yen for 20 years, and a very tight money policy.
Yet, the country is now deeply enmeshed in deflation and stagnation (see cover today's WSJ).
Property and equity markets are down by 75 percent in Japan in last 20 years. It is rotten.
On a per capita GDP basis, statist France has outperformed Japan in the last 20 years.

Why would tight money work for the USA when it has suffocated Japan?

Scott Grannis said...

Benjamin: It's true Japan has had a strong yen for many years, but it's not necessarily the case that the strong yen has been the cause of Japan's allegedly weak growth. In fact, as I pointed out in a post awhile ago, on a per worker basis, Japan's growth has been comparable to ours. Your belief that easier money is the solution to all problems, and your assumption that easier money will result in real growth, are not well founded. There is no evidence, in fact, that monetary policy in the US is tight. On the contrary, all the evidence points to monetary policy being quite accommodative. Even the Fed acknowledges this. In any event, printing money cannot stimulate growth; all it does is stimulate inflation, and that is eventually bad for growth.

Scott Grannis said...

Benjamin: It's true Japan has had a strong yen for many years, but it's not necessarily the case that the strong yen has been the cause of Japan's allegedly weak growth. In fact, as I pointed out in a post awhile ago, on a per worker basis, Japan's growth has been comparable to ours. Your belief that easier money is the solution to all problems, and your assumption that easier money will result in real growth, are not well founded. There is no evidence, in fact, that monetary policy in the US is tight. On the contrary, all the evidence points to monetary policy being quite accommodative. Even the Fed acknowledges this. In any event, printing money cannot stimulate growth; all it does is stimulate inflation, and that is eventually bad for growth.

Benjamin said...

Well, Japan is a fascinating case, to be sure.
They have engaged in massive fiscal deficit spending--one could argue that their GDP per worker has risen along with that of France and the USA, so therefore massive deficit-spending is fine and dandy.
I think Japan has harmed itself seriously, with loose fiscal and tight monetary policies. The worst of both worlds.
People today forget when Japan was slated to eclipse the USA as the world's largest economy. Then, the bubble burst.
They went to deficit spending to keep demand stable--rather than inflate out it, thus giving back nominal values to property and equities, and pay down debts.

Well, I suppose no one can prove their case on Japan--one can always argue, "It would have been better if they what I recommend."

But it is worth noting that Milton Friedman went to Japan in the 1990s and told them to print money.

If even MF thinks they were too tight, then I suspect they have been too tight.