# Cobra’s Unemployment slithers as Capacity Utilization drops

Capacity utilization dropped in November. The drop makes me reflect upon when I first began formulating the equations for effective demand in 2012-13. I made predictions to test the equations. Each prediction guided me to understand effective demand. One early prediction was that the natural rate of unemployment was around 7%.

This graph comes from a post in May, 2013. The linear trend line for the red dots was heading toward a y-intercept of 7.25, where UT goes to 0%. (UT at 0% represents 0% spare capacity or full-employment of labor and capital.)

The problem was using a linear trend line for only a portion of the data points. The trend line should have been a polynomial using both the red and yellow dots. It would have given a y-intercept of around 6%.

The latest version of the graph looks like this…

Currently the y-intercept is trending to 4.9%. The other trend line shows a natural unemployment rate of 5.1% for data before 2009.

But the unemployment rate ended up falling well below the “better” natural rate of 6%. How did I explain that?

I found the Cobra equation back in October, 2013, to show how unemployment and capacity utilization move together along the effective demand limit. The equation gives a path of increasing profits alongside the effective demand limit.

The Cobra equation implied that as unemployment falls at the effective demand limit, capacity utilization will also fall instead of rise… giving more room for unemployment to fall further. Business cycles had followed this equation before… Would this business cycle follow it?

I was not sure at that point how low unemployment would really go. I wrote back in October, 2013…

“I was projecting a lower limit of 7% for unemployment, but that was based on capital utilization rising. Now I have to reconfigure how low unemployment might go.” link

So did capacity utilization and unemployment end up following the Cobra equation? Yes, near the end of 2014, they started following the Cobra’s profit-max limit. Here is the latest graph using monthly data that includes the data for capacity utilization that came out today.

Conclusion

Just as the Cobra equation predicted, aggregate capacity utilization dropped so that unemployment could slither further downward along the profit-max limit… and it fell nicely parallel to the limit.

Finding the Cobra equation in 2013 before the economy followed it again in this weird business cycle gives me comfort. The original model of a natural unemployment rate was re-worked to a better model of unemployment along the effective demand limit.

Manufacturing is at a cycle high. Sorry, but much like utilities caused capacity to rise beyond its real growth rate, now it is falling back to what its real growth rate in manufacturing is.

Profits aren’t falling like you think Ed.

Bert,

I predicted a pattern based on past movements of capacity utilization. The prediction was spot on. Coincidence?

And the idea is to look at aggregate profits… not individual sectors.

Sorry this is for previous thread, but in fact the market jumped smartly after the interest rate announcement from the Fed, as I forecast.

And, no, Edward, I am not going to be nicey nice about your stock market attractor and claiming that Mosler thinks it is wonderful does not cut the mustard with me. I am afraid I know a whole lot more about nonlinear dynamics than he does.

Barkley,

The Dow is down today as I expected. I do not expect it to go down as low as 17,300. But it will eventually get there.

There is a difference between price and value. The Dow is raising its price due to money flows but the price has to come back to value.

Edward:

You are talking expectations from a Fed increase, the same as spreading the frosting a little thicker on the cake. I agree, the Dow will decrease. Setting the stage for a new recession because of something which never really took place. No wage inflation, low prices on energy, and a huge capacity of unused and underutilized Labor.

Run,

To put a point on your comment, effective demand decreased with a lower labor share. The result was a lower utilization of labor and capital. Lower labor through lower labor force participation with marginalized workers. Lower capital with a lower capacity utilization which never made it back up to its former levels.

The underutilization of both labor and capital is explained by the effective demand equation.

Barkley,

Look at where the Dow is today… right where I said it would be a year ago. It will tend to orbit this value of 17,300 until the contraction comes.

Here are various stock indices normalized to gdp :

https://research.stlouisfed.org/fred2/graph/?g=2WCS

The Nasdaq appears most over-valued by this metric. Given the prospect of rising rates going forward , I don’t see why anyone would find stocks attractive in the medium- to long-term at current price/gdp ratios.

Note that the graph only shows thru 2015 Q3 , so current ratios might be somewhat lower.