Should the Federal Reserve Monitor the Capacity Utilization Rate?

John Tamny observes that the capacity utilization rate has reached 81.3% and wonders why the FED is raising interest rates. Mark Thoma reads Tamny’s argument that we should only worry about world aggregate demand as compared to world supply and says:

This is wrong.

OK, that statement was actually in response to the tired old truism that inflation is a monetary phenomenon, which Tamny repeats ad nauseam without ever understanding the concept.

Tamny rests his case on an absurd notion of factor mobility:

Ip’s reasoning requires one to believe that the U.S. economy is isolated, activity within it static, and operating without integration in the world economy. Much as trade “imbalances” are irrelevant in what is increasingly an integrated world economy, so too are perceived labor and capacity shortages. Indeed, with the continued penetration of 100 million-plus workers from the former Soviet Union, China, and India into the labor force, the notion of coming labor shortages seems pretty farfetched.

The immigration debate should be one clue that labor is not as mobile as Tamny assumes. But capacity utilization involves machinery not labor and physical capital is even less mobile. Tamny tries to address the lack of physical capital mobility thusly:

Domestically, it has to be remembered that as opposed to being static, capacity is ever changing. Be it through the expansion of existing plants, the introduction of robotics, or innovation that expands output from existing facilities, capacity is a fluid concept that should not be measured in terms of the here and now.

Capital is even mobile across time? Excuse me, but investment represents accumulation OVER TIME. Also remember what Tamny’s NRO colleagues tend to ignore – Bush’s fiscal stimulus (which they endorse) reduce national savings and investment. But wait a second – what about the possibility that we can consume products made abroad:

it should be remembered that U.S. shoe and apparel maker Nike has never manufactured any of its products in the United States; that while airplane maker Boeing is based in Chicago, it will manufacture its 787 Dreamliner in six different countries around the world; that the design of Apple Ipods occurs in the U.S., but the components necessary to create the Ipod are imported. In other words, while U.S. companies design their products here, they access the world for capacity, making any domestic capacity measures irrelevant.

Granted – we can investment more than we save if are willing to amass debts to the rest of the world. But doesn’t GDP, which measures domestic production, include net exports (albeit this is currently a large negative number). So what is Tamny talking about? Perhaps he’s still on his absurd notion that the Hume Specie Flow forces all nations to have the same monetary policy and inflation rate. Perhaps someone should tell Mr. Tamny that we left the fixed exchange rate regime known as Bretton Woods over 30 years ago.

While I think the FED should monitor the capacity utilization rate, I’m not happy that the FED has been raising interest rates. The above graph of the capacity utilization rate may help explain why. While the capacity utilization rate is certainly well above where it was at the end of 2001, it is still short of where it was during the late 1990’s. In other words, the statistic is suggesting we are not yet at full employment.