Long Term Perspective

The Federal Reserve monitors capacity constraints because they indicate where supply bottlenecks are developing and inflation is percolating. The capacity utilization rate in the economy’s industrial sector is down sharply from the cyclical highs established in 1995 and again in 1997. The National Bureau of Economic Research (NBER) declared that the previous business cycle peaked in March 2001. Yet, the capacity utilization rate was declining long before the recession began. The employment-to-population ratio is more comprehensive than the jobless rate in revealing labor market conditions. This index peaked about one year before the most recent recession began in 2001. Both measures increased steadily through 2005 and most of 2006, but the employment-to-population ratio has been edging down since late 2006.

Short Term Perspective

The employment-to-population ratio remains low by historical standards for late in expansion and remains high enough to be a concern for the Fed despite the recent softening in payroll employment. The capacity utilization rate increased dramatically from mid-2003 to mid-2006, peaking above 80 percent, when analysts worry that potential supply bottlenecks will lead to inflationary pressures. After some softening in late 2006 and early 2007, the capacity utilization rate picked up in mid-2007 in response to a pickup in production. But capacity utilization appears to be easing off a bit in the second half of 2007.