Transcript Economics, by R. Glenn Hubbard and Anthony Patrick O`Brien

Industrial Production & Capacity Utilization
Web address: www.federalreserve.gov/releases/g17/current
Industrial Production (IP) Index:
IP covers nearly everything produced in the U.S. (20% of the economy) for manufacturing (82%), mining (8%), electric utilities (10%) and gas
industries.
Does not include output from agriculture, construction, transportation, communications, and service industries.
Measures changes in the volume of goods produced (does not take price into account)
IP corresponds to real GDP (close relationship between DIP and DGDP)
Manufacturing is most cyclically sensitive part of economy, follows the ups and downs of the business cycle.
Manufacturing activity is highly sensitive to changes in interest rates and aggregate demand.
Good forecaster of manufacturing employment, average hourly earnings and personal income
IP data has 2 formats:
Supply Side: Output by industry (manufacturing, mining, utility)
Demand Side: Type of product, (consumer/business/intermediate goods and materials)
Real GDP growth estimator = 3-month DIP/IP
Nominal GDP/Factory Sales/Manufacturing Revenues Growth estimator =
(3-month D IP/IP) x (3-month D CPI/CPI)
Capacity Utilization (CU):
Present production divided by maximum potential production capacity
81% long-run average
Measure of spare capacity/slack at factories, mines, utilities.
Leading indicator of business investment spending and inflation pressures.
High CU => rising investment spending and hiring, shortage of vendor parts, higher prices
Low CU => low investment spending and hiring, surplus of vendor parts, lower prices.
Follows the ups and downs of the business cycle.
CU = 82-85% => production bottlenecks => rising producer prices
-------------------------------------------------------------------------------------------------------------------------High IP/CU => fast growing economy => rising profits => rising stock prices
=> production bottlenecks => rising inflation => rising interest rates => falling bond demand
=> fast growing economy => rising demand for dollar => rising exchange rate
Industrial Production Index
(2007 = 100)
10%
120
8%
115
6%
110
4%
105
2%
100
0%
95
-2%
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
90
-4%
85
-6%
80
-8%
75
-10%
70
-12%
65
-14%
60
-16%
55
Recession
IP Y/Y Growth
IP Index
Capacity Utilization
(Total and Manufacturing)
90
90
88
88
86
86
84
84
percent
Full capacity = 82-84%
82
82
80
80
78
78
76
76
74
74
72
72
70
70
68
68
Recession
66
64
Total
Manufacturing
62
66
64
62
82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Liquidity Preference Analysis
Derivation of Demand Curve
1. Keynes assumed money has i = 0
2. As i , relative RE on money  (opportunity cost of
money )  Md 
3. Demand curve for money has usual downward slope
4. QDM = f(i; Y, P)
- + +
Income Effect: Y => QDM at each i (DM )
Y =>W =>DM as medium of exchange and store of value
Price Level Effect: P =>QDM at each i (DM )
People care about purchasing power of money,
real money balances = X = M/P
Velocity of Money = V
(rate of money turnover)
(link between M & PY)
MxV=PxY
Equation of Exchange
(identity)
DM/M + DV/V = DP/P + DY/Y
DP/P = DM/M + DV/V - DY/Y
If DV/V = 0,
Then DP/P = DM/M - DY/Y
If DM/M > DY/Y
Then DP/P > 0
If DM/M = DY/Y
Then DP/P = 0
Milton Friedman: “Inflation is everywhere and always a monetary
phenomenon”
Deposit Interest Rates
versus Fed Funds
7
6
Percent
5
4
3
2
1
0
92
93
94
95
Source : CUNA's E&S
96
97
98
99
00
01
Fed Funds
MMAs
02
03
04
05
06
07
08
Regular Shares
CDs
09
Money Demand Growth
(Checking, Savings, MMA)
Monthly Growth
Interest Rate
2.0%
8.0
1.5%
6.0
1.0%
0.5%
4.0
0.0%
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
2.0
-0.5%
-1.0%
0.0
Recession
Money Growth
Fed Funds Rate
Money Demand (Savings) Curve
4
CD/Savings Rate Differential
07
3.5
3
06
95
01
002.5
97
2
98
96
99
1.5
05
1
0.5
04
94
03
02
93
92
0
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
Monthly Savings Balance Growth
2.0%
2.5%
CD Growth
Interest Rate
Monthly Growth
4.5%
8.0
4.0%
3.5%
3.0%
6.0
2.5%
2.0%
1.5%
4.0
1.0%
0.5%
0.0%
2.0
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
-0.5%
-1.0%
-1.5%
0.0
Recession
Source: CUNA's E&S
CD Growth
Fed Funds Rate
Loanable Funds (CD) Supply Curve
CD/Savings Rate Differential
4
07
3.5
3
06
2.5
01
95
00
2
98
97
96
99
05
1.5
1 04
02
03
92
-3%
-2%
0.5
93
-1%
0
0%
94
1%
2%
Monthly CD Balance Growth
3%
4%
5%
GDP Output Gap vs.
Federal Funds Rate
8%
11%
7%
10%
6%
9%
5%
4%
8%
3%
2%
7%
1%
6%
0%
-1% 85
88
91
94
97
00
03
06
09
-2%
12
5%
4%
-3%
3%
-4%
-5%
-6%
-7%
-8%
2%
Recession
1%
Output Gap (LHS)
Federal Funds Rate (RHS)
Source: CBO & Federal Reserve.
0%
11
Consumer Price Index
1970 to Present
14
13
13.3
12.5
12.3
Hoarding money => deflation
Austerity => stagnation/deflation
Deflation => rising purchase power of dollar
Deflation => lower wages => rising debt burden
12
11
10
9
8
8.9
6.9 6.7
7
6
9.0
8.7
6.1
2.5% Target
5.6
4.9
5
4
Deflation leads to:
•Households postpone spending
•Rising real interest rates
•Rising debt burdens
3.83.84.0
3.8
3.33.4
4.7
4.44.4
4.1
3.4
3.33.5
2.6
2.5
2.4
1.9
1.71.6
1.6
3.3
3.12.9
2.72.72.5
3
2
2.8
3.0
1.4
1.7
1.1
1
0
-1 70 72 74
76 78 80
82 84
86 88 90
92 94 96
98 00 02
04 06 -0.1
08 10 12
Inflation (CPI)
(year over year % growth)
6%
5%
4%
3%
2%
1%
0%
95
96
97
98
99
00
01
02
-1%
-2%
-3%
Headline
Core (excludes food and energy)
03
04
05
06
07
08
09
10
11
12
13
Taylor rule A rule developed by John Taylor that links the Fed’s
target for the federal funds rate to economic variables.
Federal funds target rate = Current inflation rate + Real equilibrium
federal funds rate + (1/2) x Inflation gap + (1/2) x Output gap
Inflation targeting Conducting monetary policy so as to commit
the central bank to achieving a publicly announced level of
inflation.
Consumer Confidence/Sentiment Index
(Real Time Measures of Consumers Attitudes on Economy, Personal Finance, and Future Spending)
Web: http://www.conference-board.org/economics/consumerConfidence.cfm
Web: http://www.sca.isr.umich.edu/main.php
Minor revisions
Happy consumers are good for business so index is useful for predicting consumer spending. Unfortunately, the
relationship between confidence index and spending is not a close one.
Difficult to predict how humans will behave. Sales are the best method of measuring consumer confidence.
A six month moving average of confidence is a better indicator of future household outlays.
Index is important during economic turning points. Better at forecasting recessions than recoveries.
Consumer confidence Index polls 5,000 new households, the survey has 5 questions with emphasis on labor
market conditions - which can lag the economy
Consumer Sentiment Index polls 500 new and continuing households (the rotating interview strategy is 60%
new and 40% second time interviews => less erratic index), 50 questions with emphasis on financial and
personal income expectations which is a driving force behind consumer spending => better leading indicator.
------------------------------------------------------------------------------------------------------------------------------------------------
Market Analysis:
Bonds:  Confidence =>  borrowing/spending =>  DP/P =>  DBonds =>  iBonds
Stocks:  Confidence =>  borrowing/spending =>  DY/Y =>  profits =>  PStocks
Dollar:  Confidence =>  borrowing/spending =>  DY/Y =>  iBonds =>  dollar
150
Consumer Confidence &
Sentiment Index
150
140
140
130
130
120
120
110
110
100
100
90
90
80
80
70
70
60
60
50
50
40
40
30
30
20
20
10
Recession
Confidence
10
Sentiment
0
95
96
97
98
99
00
01
02
03
Source: Conf erence Board & University of Michigan
0
04
05
06
07
08
09
10
11
12
13
14