Economic statisticians don't have to worry much about job security. The wheel of economic data releases keeps on spinning month after month, and there's always something new for economists, analysts, and investors to use to update their economic models. Already, you're starting to see new versions of reports that were discussed in articles last month, such as the producer price index. However, because monthly reports are sometimes released on different dates each month, there are still some sets of data that you haven't yet seen. In addition, some reports, such as the report on the current account, are released only on a quarterly basis.
Among the data you've seen have been numerous sets of information about business activity. Because a relatively small number of major industrial businesses make up such a huge portion of the overall national economy, it's far easier for economic statisticians to gather data on business activity than to try to gauge the behavior of nearly 300 million individual American consumers. Reports like the construction spending report and the report on factory orders provide detailed information about the volume of transactions among various types of businesses.
Another report that adds a new twist to the available information on American businesses is the Federal Reserve's release of its index of industrial production and capacity utilization rates. As the name suggests, this release measures current levels of production not only in absolute terms but also in comparison to the potential maximum output possible. This article discusses the industrial production and capacity utilization numbers in more detail.
The basic concept
The Federal Reserve's data on industrial production measures the inflation-adjusted economic output of three categories of businesses: manufacturing companies, mining businesses, and electric and gas utilities. The numbers are incorporated into an index that is tied to a particular base year; currently, an index figure of 100 corresponds to the production levels that existed in 2002. To calculate the index, the Fed gathers information about how much of various products businesses made in a given month; in cases in which actual production figures are difficult to find, the Fed looks instead at the flow of raw materials and infers production figures based on how much raw material was used. The Fed then uses price indices from the Bureau of Economic Analysis and applies weighting factors to each industry based on its relative contribution to overall production levels. The weighted numbers are then adjusted to reflect changing seasonal conditions. The resulting index reflects current production activity and allows comparisons with previous periods. Separate indices are also calculated for the manufacturing, mining, and utility industrial subgroups, and other indices break down production by consumer goods, business equipment, nonindustrial supplies, and materials.
The method used to calculate industrial production is relatively straightforward. Determining the capacity utilization numbers, on the other hand, requires more extensive research. The capacity utilization rate measures the percentage of theoretical maximum production levels that are actually being used. For example, if a particular factory produced $10 million in goods in a month, but it could have produced $20 million if it had been running at full capacity, then the factory's capacity utilization rate would be 50%.
The challenge in determining capacity utilization is figuring out what the theoretical maximum sustainable output level is. Because this information isn't directly available, the Fed has to derive capacity figures from more basic source data, including figures from the Energy Department and private trade industry organizations. The Fed also draws data from a survey of plant capacity done by the Census Bureau. A complicated statistical model produces figures which are then seasonally adjusted to produce the final results. Typical capacity utilization rates are around 80%; levels above 90% have only occurred in times of war.
The news release also includes brief explanations and breakdowns behind some of the data. These explanations are often helpful in identifying the primary reasons why a particular index moved up or down.
Economists generally use the industrial production index as an indicator of the strength of the overall economy. The index has performed strongly over the past several years, but growth levels have slowed over the last three months. Today's release of data reported the first significant monthly drop in the overall industrial production index since Hurricane Katrina shut down a large portion of Gulf Coast regional production last year. Although the figure is somewhat volatile and subject to revision over the next several months, the monthly series appears to be indicating a slowdown in the economy.
In addition to supporting conclusions about the overall economy, the capacity utilization data add some hints about other economic factors. Some economists argue that high capacity utilization can indicate demand that is approaching the limits of available supply, which can lead to short-term shortages and price inflation. Low capacity utilization, on the other hand, can cause businesses to evaluate their production efficiencies, and if they last for an extended period, businesses may choose to shut down production facilities, increasing unemployment levels and creating a ripple effect throughout the national economy. Capacity utilization fell in today's report, easing some concerns about inflation and leading some commentators to conclude that the Fed may not need to raise interest rates again during this economic cycle.
For investors, the separate information for manufacturing, mining, and utility production can be extremely helpful in evaluating companies in those industries. In the current report, mining production actually rose, while utility production fell much more sharply than the overall figures. By reflecting activity within companies such as precious-metals producers Stillwater Mining
In summary ...
The Federal Reserve's release of data on industrial production and capacity utilization gives economists and investors more information about the health of the country's biggest industrial companies. By looking not only at the headline figures but also the details within the report, you can learn more about the prospects for production-related stocks that you own now or in which you may invest in the future.
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Between writing and taking care of his daughter, Fool contributor Dan Caplinger sometimes feels that his capacity utilization is running at about 110%. He doesn't own shares of any of the companies mentioned in this article. The Fool's disclosure policy always has enough capacity for you.