How Much Slack is Left?

The Federal Reserve reported today on industrial production and capacity utilization. From the report:

Industrial production rose 0.1 percent in August, and at 119.7 percent of its 1997 average, was 3.1 percent above its year-earlier level. Manufacturing output increased 0.3 percent; excluding motor vehicles and parts, manufacturing production was unchanged from July. The output at mines declined 0.6 percent, and the output at utilities decreased 0.5 percent. Hurricane Katrina severely curtailed output in the Gulf Coast region at the end of August; hurricane-related production declines were most evident in oil and gas extraction, industrial chemicals manufacturing, and petroleum refining. Overall, the rate of change in total industrial production in August was reduced by an estimated 0.3 percentage point because of disruptions related to the hurricane. Capacity utilization for total industry was 79.8 percent, a rate that is 1.5 percentage points above its year-earlier level but 1.2 percentage points below its 1972-2004 average.

The industrial side of the economy has been steadily recovering from its slump of 2001-03, though as the release points out, the US economy is still running at substantially below its typical level of capacity utilization. More worryingly, recent advances in capacity utilization seem to have recently been petering out.

This brings us once again back to the unresolved question of the summer: how much slack is left in this economy? Or, put another way, how much more production can we get out of this economy before significant price pressures start being felt?

As the chart below illustrates, even the reasonably good recovery in industrial production of the past couple of years has left the US economy using just under 80% of its total industrial capacity, which is substantially below its historical “full” capacity of 82-83%. The chart also illustrates that the US economy’s utilization of its labor force has recovered by even less.

So while this is an economy that is probably in the mature phase of its economic expansion (an expansion that has been ongoing for almost 4 years now), the economy has still failed to get into full swing. Since different measures give different answers, it is unclear exactly how much slack remains in the economy… but nearly all measures still suggest that we have some way to go before we’ve fully recovered from the 2001 recession.