The Oracle of Dallas
Back in 2001, Robert McTeer, then head of the Federal Reserve Bank of Dallas, offered a refreshingly straightforward approach to monetary policy. "When capacity utilisation hits X and the unemployment rate hits Y, come and talk to me about rate cuts," he declared, eschewing the arcane models beloved by his peers. Two decades on, his focus on tangible economic indicators remains as pertinent as ever.
Inspired by McTeer's pragmatism, we developed a Fed Funds model based on three real-world metrics: capacity utilisation, industrial production, and inflation. This trinity has proved remarkably prescient, even anticipating seismic shifts like the advent of Quantitative Easing. Yesterday's release of industrial production and capacity utilisation data, therefore, merits close scrutiny.
Capacity utilisation is a key barometer of economic health. High rates often presage inflationary pressures as businesses raise prices in response to surging demand. Conversely, low rates typically signal muted inflation. Unsurprisingly then, US inflation peaked in June 2022, just two months after the peak in capacity utilisation. However, yesterday's data showed capacity utilisation at 77.5%, languishing some 2.2 percentage points below its long-term average, suggesting subdued inflationary forces.
Industrial production, meanwhile, offers a concrete measure of economic output. Here, the picture is less rosy. Despite overall economic expansion, industrial production has stagnated since 2007, betraying a structural shift away from manufacturing. Yesterday's figures showed a mere 0.4% increase from the level of December 2007, underlining this trend. Not all service sector activities contribute to wealth creation as manufacturing does, and the sector remains a vital engine of innovation and productivity growth.
Moreover, much of America's post-2008 growth has been fuelled by government borrowing, raising questions about its sustainability. When viewed alongside declining capacity utilisation and weak industrial production, it appears that inflationary pressures are likely to remain muted.
McTeer's insight retains its relevance. By closely monitoring capacity utilisation and industrial production, we can apply our model to make predictions of potential monetary policy shifts. Current readings suggest that inflationary pressures are easing and that the American economy has room to expand without triggering a resurgence in prices.
For now, the Federal Reserve's steady-as-she-goes approach to interest rates seems justified. But the reliance on debt-fuelled growth casts a long shadow over the economic horizon. As McTeer might say, when the debt-to-GDP ratio hits Z, come and talk to me about sustainable growth.
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