Report

Capacity utilization-inflation linkages: a cross-country analysis

Abstract: This paper analyzes whether capacity utilization in manufacturing is a reliable inflation indicator over and above economy-wide indicators of inflationary pressure and examines different theories on the propagation of inflation by testing their implications for the relationship between capacity utilization and inflation. Three mechanisms whereby shocks to manufacturing can impact on inflation are explored: First, direct pressure on producer prices in manufacturing arising from bottlenecks and a slowdown in productivity growth at high operating rates, second, spill-overs of manufacturing-sector wage increases into inflationary wage growth in the service sector, and finally, investment in manufacturing capacity that stimulates expansion, capacity pressures, and inflation on an economy-wide basis. We find that manufacturing capacity utilization has marginal predictive power for inflation in seven out of 15 major OECD economies and that the inflationary impact of an increase in manufacturing operating rates tends to be sizable. The links between capacity utilization and inflation that we uncover suggest that the mechanisms that propagate inflationary impulses differ widely among nations. In the U.S. there is strong evidence that changes in manufacturing activity impact on inflation through unit labor costs and finished goods producer prices. By contrast, wage contagion appears to be a crucial element of the inflation process in Japan. It also plays a role in Europe, particularly in Germany. Finally, only in Germany of the major capital-goods producing economies, does capital goods prices unambiguously play a role in transmitting manufacturing-sector shocks to economy-wide price indices.

Keywords: Organisation for Economic Co-operation and Development; Industrial productivity; Industrial capacity;

Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Research Paper

Publication Date: 1996

Number: 9607