US resource utilisation: Lower over the long term, slower over the short term

Even as markets push interest rates higher over the past few weeks in the face of data showing that the US and global economies remain robust and central banks' apparent willingness to raise official rates higher, not everyone is convinced that the strength of the economy is sustainable or that it warrants higher interest rates.

In her Bloomberg article on 3 March, Caroline Baum wrote that the US economy looks headed for a slowdown. Consumer spending has slowed on a year-over-year basis while debt burdens are rising, with debt payments as a share of disposable income having risen to an all-time high of almost 14 percent in the third quarter. As for investment, she pointed out that with growth slowing, companies are not likely to get aggressive about investing while residential investment is showing signs of deceleration.

In another article on 7 March, Baum looked at the US labour market for evidence of tightness and she found little.

First she dismissed tightness in industry capacity utilisation. "When Fed policy makers talk about resource utilization in today's produce-it-where-it's-cheapest world, they aren't talking about the industry operating rate, which stood at 80.9 percent in January, a touch below the 33-year average," she wrote.

She acknowledged the improvement in the unemployment rate, "which dipped to a 4 1/2-year low of 4.7 percent in January, down from a cycle peak of 6.3 percent in June 2003", but then dismissed the significance of the fall by pointing out that "the U.S. economy experienced high unemployment and inflation simultaneously in the 1970s and low unemployment and inflation in the 1980s". In any case, she pointed out that the "percentage of the population that is in the labor force (employed or unemployed) has been drifting lower since its peak in the first quarter of 2000 (66.9 percent)".

Turning to the average workweek, she wrote: "The average workweek has been flatlining for 3 1/2 years at 33.6 to 33.8 hours. That's well below the average of 34.3 hours in the 1990s, 34.8 hours in the 1980s and 36.3 hours in the 1970s -- all decades that had their share of workweek-depressing recessions."

As for wages, she pointed out that average hourly earnings have risen, but at a pace barely ahead of inflation. "Labor's share of the income pie was 57.4 percent last year, up from 56.7 percent at the 1997 trough but well below the 1980 peak (61.1 percent)," she wrote.

She concluded: "Unless the adverse effects of the tight labor market surface soon, policy makers may have to find another justification for raising rates."

However, while what Baum says is essentially correct, in her attempt to link the labour market to monetary policy, it would probably be useful to distinguish between long-term and short-term trends.

Baum's 7 March article highlights a long-term trend of lower resource utilisation (the article alludes to globalisation as a factor behind this trend, at least for industry capacity). While Baum seems to be saying that the low utilisation rates suggest that interest rates should not be raised any further, it is worth remembering that this long-term trend is not the result of higher interest rates -- indeed interest rates are also at historically low levels.

So keeping rates at current low levels would not address the underlying factors behind this trend. In fact, it could potentially aggravate the debt problem that she cites in her 3 March article as a reason why consumer spending may slow.

If long-term trends suggest some degree of inevitability in lower resource utilisation -- at least with respect to interest rates -- do short-term or cyclical trends indicate any short-term overheating in the economy that warrants further interest rate hikes?


The chart above shows that the year-on-year change in industrial capacity utilisation is at the upper end of its historical range, but already slowing from its peak in 2004. Similarly, the year-on-year change in average weekly hours appears to have already peaked. These observations arguably add more substance to the view that the Federal Reserve should stop its hiking campaign -- or at least be close to stopping -- if its wants to avoid a recession.

More likely, though, most who think that the Federal Reserve should halt would base their opinion on the inverted yield curve -- 2-year Treasuries now yield more than 10-year Treasuries. If that does not stop the Federal Reserve from further rate hikes, squiggles like those on the above chart are not likely to either.