JAMES E.

KENNEDY
Board of Governors of the Federal Reserve
Washington, D. C.

An Analysis of Wme-Series
Estimates of Capacity Utilization*
The Federal Beserve's capacity utilization series constitute an important indicator of resource
utilization. Because capacity is difficult to measure, this paper considers time-seties alternatives.
All that is needed to estimate the permanent component is an IP index. The time-series measures have the advantage of being consistently measured over time and easily reproducible. The
FRB series are evaluated relative to the alternatives in terms of their ability to explain and
predict inflation. The alternatives generally perform as well or better than the FRB series in
these tests.

1. Introduction
One of the basic propositions in macroeconomics is that price inflation
accelerates as resource utilization moves higher. Indeed, the empirical evidence in support of this relationship is deemed so convincing that most
economists consider it a necessary feature of macroeconomic theory. 1 The
two most often cited measures of resource utilization are the civilian unemployment rate and the Federal Reserve Board's series on capacity utilization. This paper focuses on capacity utilization. The FRB utilization rates
are compared to a set of time-series alternatives calculated using the
Hodrick-Prescott (HP) filter. We evaluate the utilization measures in terms
of their ability to explain current inflation and to predict future inflation.
The FRB utilization series have a number of commendable features.
For example, they are published on a timely basis and are available for both
manufacturing as a whole and for highly disaggregated manufacturing industries. The FRB uses a variety of information in putting together its capacity estimates. Moreover, the manufacturing utilization rate, which receives considerable attention in the press, tracks fairly closely with a number
of measures of inflation, including the producer price index.
*The views expressed in this paper are those of the author and are not necessarily shared by
the Federal Reserve Board or its staff. Carol Corrado, Joe Mattey, Richard Raddock, and Bill
Wascher provided many useful suggestions.
1For example, Lucas (1977).

Journal of Macroeconomics, Winter 1998, Vol. 20, No. 1, pp. 169-187

Copyright 1998 by Louisiana State University Press
0164-0704/98/$1.50

169

James E. Kennedy
Nevertheless, there are at least a couple of reasons to consider alternatives. First, some of the source data for the FRB estimates have changed
over time and other source data have disappeared. This raises the question
as to whether FRB capacity is being measured consistently. The time-series
alternatives that we consider are i m m u n e from this problem because they
are calculated exclusively from data on industrial production. Second, as
many researchers have noted, it is difficult to come up with a definition of
capacity that is well-grounded in economic theory and also is amenable to
measurement. The FRB gets around this problem by working with a practical definition of capacity, one that is loosely linked to economic theory and
is well suited for measurement. By contrast, the time-series estimates take
an agnostic view: capacity simply is defined as the stochastic trend in output. 2
These estimates have a n u m b e r of desirable properties: they are essentially
costless to generate, easily reproducible, and consistently measured over
time.
In the discussion that follows, the empirical properties of the FRB
utilization series are c o m p a r e d to the time-series estimates. W e assume that
the primary usefulness of capacity utilization is in its ability to explain current
inflation and to predict future inflation. This implies that it is largely an
empirical question as to which set of measures is preferred. This criterion
has been used by others. For example, after noting the ambiguities in various
definitions of capacity, Perry argued: "In the absence of a more precise
definition, the saving feature of any of the present capacity and utilization
indexes must be the a s s u m p t i o n . . , that the index is consistent through time
so that at least it is always measuring the s a m e - - i f unspecified--concept.
The usefulness of the measure can then emerge in its ability to predict."
(Perry 1973, 705).
Our main interest is in how the utilization series are related to producer price inflation. Among other things, we estimate Phillips-curve equations that include either FRB utilization or the H P alternative. The results
show that the time-series utilization measures generally perform at least as

ZApaper by Clark provided an interesting analog. Rather than a structural model, he used
Okun's shortcut to estimate potential GNP. "For whatever reason, the cyclical movements of
unemployment and real GNP are very closely related .... This close relationship suggests that
an "Okun's Law' calculation may be one of the most accurate methods of estimating the underlying trend in real output .... It would be difficult to make a case for using Okun's shortcut
to estimate potential GNP ff there existed structural models for productivity growth, labor force
participation and length of workweek. However, research in the underlying trends in each of
these factors is still in its infancy. Given this general lack of understanding about the forces
which produce secular increases in real output.., a direct estimate of potential output using
Okun's Law is probably better than more complex calculations aimed at finding the trend in
each piece separately." (Clark 1983, 8-9)
170

An Analysis of Time-Series Estimates

well as the FRB series in these regressions, and often better. We also conduct tests for Granger causality from utilization to prices. These tests indicate
that the HP rates contain somewhat more leading information for inflation
than the FRB rates.
The outline of the paper is as follows: The second section contains
brief descriptions of both the FRB capacity series and the time-series estimates. The third section presents some descriptive statistics. It then compares the ability of the FRB and HP utilization series to explain current
inflation and to predict future inflation.

2. A Description of the Capacity Series

What is Capacity?
The term "capacity" often evokes a sense of a ceiling on production;
this is referred to as engineering capacity. It has long been recognized that
this definition is largely irrelevant to economists. For example, a number of
studies have found that the capital stock in the U.S. is idle most of the time.
One of the earliest, by Foss (1963), reported a workweek of capital of only
38 hours per week. Presumably, most of this idleness is optimal.
Economists define capacity much differently. For example, Winston
(1974, 17) stated: "Full capacity describes a firm's planned [or] intended...
level of utilization; the level that reflects satisfied expectations, is built into
the capital stock, and is embodied in the normal working schedule." For a
firm in a competitive industry, this level of output is at the minimum point
of its short-run average cost curve. When the economy as a whole operates
at this level, the labor market clears and capital is fully utilized) Klein and
Long (1973) have noted that capacity also may be considered a "bottleneck
point" in a general equilibrium system.

FRB Capacity
The methods used in constructing the FRB capacity series are well
documented in a number of articles; this section offers only a general description. 4 In its monthly report on industrial production and capacity utilization, the FRB defines capacity as follows: "The capacity indexes attempt
to capture the concept of sustainable practical capacity, which is defined as
the greatest level of output that a plant can maintain within the framework
of a realistic work schedule, taking account of normal downtime, and assuming sufficient availability of inputs to operate the machinery and equipment
aLucas (1970), among others, offers a formal theoretical model.
4Examples include Raddock(1994 and 1995).
171

James E. Kennedy
in place" (Board of Governors of the Federal Reserve System 1995, 18). This
level of output does not necessarily represent either the maximum that can
be extracted from a fixed plant (as indicated by utilization rates that sometimes exceed 100%) or the level associated with the minimum point of the
short-run average cost curve. 5
The FRB method requires first finding an anchor for capacity, and
then using other information in order to calibrate year-to-year changes. The
first step is to divide an industrial production index by a survey-based utilization rate, which yields an implied index of capacity:
ICt = IPt/CUt,

(1)

where IC denotes implied capacity, IP and industrial production index, and

CU a survey-based utilization rate.
Currently, the FRB utilization rates are based largely on annual data
from the Census Department's Survey of Plant Capacity Utilization. This
survey is conducted every two years. The 1993 survey, for example, asked
for information on productive capacity in 1991 and 1992. 6 Census data have
been directly incorporated into the FRB estimates for the period from 1974
to 1992. For some industries, physical product data on output and capacity
are available (from trade associations, for example). In such cases, a utilization rate calculated from the available output and capacity data is used in
(1) instead of a survey-based measure. As a rule, physical product data are
available more for the primary processing industries than for those in advanced processing.
The FRB has argued that the year-to-year changes in implicit capacity
given by (1) are implausible because they show excess cyclical volatility. In
order to smooth the series, implicit capacity from (1) is regressed on the
capital stock and a deterministic function of time:
log ICt = a + log Kt + EI3,f~(t),

(2)

where K is the year-end capital stock and f~(t) is a polynomial defined on

time.fi is specified separately for each industry. The fitted values from these
5A 1978 Federal Reserve publication (p. 22) offered the following definition: "There is a
general agreement that it is impossible to define capacity fully and unambiguously.., an 'engineering' concept of capacity corresponds to the ultimate technical bound on output . . . . The
lower limit, or what might be called a 'revealed economic' concept of capacity, focuses on what
is shown to be profitable at a given time. Statistical measures of capacity, including those estimated at the Federal Reserve, tend to fall between these extremes."
6For many years a survey conducted by McGraw-Hill (MH) was an important benchmark
for the capacity estimates; this survey was discontinued in 1988.

172

An Analysis of Time-Series Estimates

regressions provide baselines for the annual FRB estimates; within-year values are interpolated. Capacity estimates for the period since the most recent
Census data are based on the extrapolated fit of (2), given information on
actual and planned investment.

Hodrick-Prescott Estimates of Capacity

The Hodrick-Preseott filter offers a straightforward alternative. This
filter decomposes a time series into a permanent and a transitory component. 7 HP define the permanent component (also referred to as the trend
or growth component) as including "those variations that are sufficiently
smooth to be consistent with slowly changing demographic and technological
factors and accumulation of capital stocks." The cyclical component comprises those variations that occur at higher frequencies and cannot be explained by such factors. HP assume that the trend varies smoothly over time
and that the growth and cyclical components are independent.
In the discussion that follows, the HP permanent component is used
as a measure of capacity. Capacity utilization is calculated as IP divided by
the HP permanent component. In the short run, either demand or supply
shocks may cause deviations of actual output from the permanent component. There are many ways in which a firm operating at "capacity" may boost
its output: adding shifts, as discussed in Marris (1964) and recently examined
by Mayshar and Solon (1993); varying line speeds; altering the product mix;
or bringing mothballed facilities back into use.
The permanent component is solved for as follows:8

rain

gt

i (l/r) T

1=2

Yt = gt + ct,

T-1 [ag
t=2

(3)
(4)

where y(t) is a time series, g(t) is the estimated trend component and c(t) is
the estimated cyclical component. ;~ is a parameter set prior to estimation
that controls the smoothness of the trend component. If )~ is set at zero,
there is no penalty for variation in the second difference of the growth component, in which case (3) is minimized by setting Yt = gt for all t. At the
7Hodrickand Prescott (1980).There are a number of other decompositionmethods;Canova
(1991) providesa fairlycomprehensivelist. We makeno presumptionthat the HP filterdelivers
an optimal decomposition;it may"well be that one of the alternativesis superior, accordingto
the criteria laid out in the next section.
STbe HP decompositionwas performed using a procedure in RATSVersion 4. See Doan
(1992).
173

James E. Kennedy
other extreme, as )~ --* % the minimization of (3) requires that Agt - Agt-1
= 0 for all t, and the problem reduces to minimizing {(1/T)T=2[y, -- gt]e}.
The solution to this expression is a linear trend.
Because the value of determines the degree of variation in the
growth component, judgment plays a crucial role in the decomposition.
Based on a priori reasoning, H P set )~ equal to 1600. The authors showed
that the standard deviation and serial correlation of the cyclical c o m p o n e n t
varied little for )~ between 400 and 6400. 9
It is important to note that the H P filter has been criticized in a n u m b e r
of recent papers, for example, Cogley and Nason (1991), King and Rebelo
(1993), and Canova (1991). One concern is that application of the filter may
dramatically alter the cross correlations between series. Despite its apparent
shortcomings, we employ the H P filter in this analysis because it is easy to
compute and its interpretation is straightforward. It turns out, as discussed
below, that for the purpose at hand--explaining current inflation and predicting future inflation the utilization series based on the H P filter do a
pretty good job. Nevertheless, in future research it may be fruitful to explore
the use of other, more sophisticated time-series filters. 1

3. Comparison of FRB Capacity with the Alternative Measures

Descriptive Statistics
We compare the FRB and H P series for manufacturing as a whole as
well as for the advanced and primary processing industries. Advanced processing includes industries such as apparel, machinery, motor vehicles, and
instruments in which most of the output is final products. Primary processing
includes industries, such as textiles, metals, and chemicals that produce materials used in downstream industries.
9Applications of the HP filter may be found in Kyland and Prescott (1982, 1990), Cooley and
Ohanian (1991), Chadha and Prasad (1993), Christiano and Eichenbaum (1990), and Hansen
(1985). In stark contrast to HP, Nelson and Plosser (1982) argued that a value of )~ between
1/6 and 1 would be more plausible. In this range there is virtually no penalty for variation in
the growth component. I calculated HP utilization rates based on ;~ = 1/6. The contemporaneous correlations between these utilization rates and inflation were much lower than those for
utilization rates based on = 1600. On the other hand, for the purpose of deriving a productivity trend Gordon (1993) settled on a value of of 25,600.
1Expenments based on other methods were conducted, including an algorithm that calculated trend-through-peaks capacity measures as defined by Klein and Preston (1967) and a filter
suggested by Beaudry and Koop (1993). For the most part, the HP utilization series outperformed each of these alternatives m terms of their ability to explain and predict inflation.

174

An Analysis of Time-Series Estimates

Pement

. . . .

Percent

lip

89

69
1960
1964
1968
Note Recl~..s~ls~e denotedtoyfflo shadedm s

1972

1976

1980

1984

1998

1992

Figure 1.
FRB Utilization Comparedwith HP Utilization Manufacturing

The HP decomposition was conducted on the 1950-92 period. 11 Figures 1 to 3 compare the FRB and HP utilization rates for the three industry
groups (HP utilization is simply IP divided by the HP permanent component). In manufacturing, the FRB and HP series show broadly similar cyclical movements. Indeed, the first differences of the FRB and HP utilization
rates for manufacturing (not shown) are remarkably similar.
FRB capacity growth for manufacturing outpaced IP growth by about
1/4 percentage point at an annual rate over the sample period. As a result,
FRB capacity utilization contains a negative trend (Figure 1). By design, the
HP permanent component grows at nearly the same rate as IP; consequently,
HP utilization does not contain a trend. The FRB capacity series generally
show smaller year-to-year variation than the HP series. For manufacturing
as a whole, the standard deviation of FRB capacity growth is 1.14 percentage
11FRB capacity currently is benchmarked through 1992. We restrict ourselves to benchmarked data, which are not likelyto revise materially.

175

James E. Kennedy
Percenl

Percent

117 - .....
114

~.

111

"~

FRB
HP

...:.-

.'..:

..

:.

109 ii:.
105

~'1::,

.":::2

..'j.

102

99

96
':'

..

:' .:

:'..

76

--

72

!.

:,.:

1960
1966
1970
Not~ Re--Ions am denoted by Me shaded areas

:,

1975

1980

1985

1990

68

64

Figure 2.
F R B Utilization Compared with H P Utilization Primary Processing

points, about one-fifth the annual variation in output. By contrast, the standard deviation of the HP permanent component is 1.59 percentage points,
about one-third the typical variation in output growth (of course, we can
make the HP trend vary as much or as little as we want by changing X).
The first column of Table 1 shows the results of adjusted Dickey-Fuller
(DF) tests applied to the FRB utilization series. 12 The test results indicate
essentially that each of the utilization series is, at best, borderline stationary.
By contrast, the HP utilization rates are stationary by design. The second
column of Table 1 shows correlations between FtlB and HP utilization. The
correlation for manufacturing as a whole is 0.81, indicating that the series
move together fairly closely over the sample period. A set of cointegrating
regression was estimated in order to see whether the series share a common
12As Christiano and Eichenbaum (1990), among others, have argued, these tests are not
capable o distinguishing precisely between, for example, a trend-stationary and a chffereneestationary process. Alternative tests also were conducted: Stock-Watson tests that allow for a
quadratic or a linear trend (Stock and Watson 1989) and Dickey-Fuller tests with no trend. The
results of these alternative tests were quite similar to the Dinkey-Fuller test results.

176

An Analysis of Time-Series Estimates

Percent

Percent

112
.....
109-

HP

:::':

.":.:'

lO61 ~:,'

:':':

.',.

"'

.i:.:i

:.:.i

.:

!II

'.

":
""
:....

/3

9O

....

i:

":):

}'.

:.

,. v::

!,.i

':'-

1952
1957
1968
NotB Recessionsam denotedby the shaded an~s

1967

,':i:"

i'
1972

1977

1982

1987

1992

Figure 3.
FRB Utilizahon Compared with HP Utilization Advanced Processing

stochastic trend. The test statistics (not reported) indicate that the utilization
series for advanced and primary processing are not cointegrated, whereas
the manufacturing utilization rates are marginally cointegrated.

T A B L E 1.

Some Descriptive Statistics on Utilization

Adjusted D F test stat.
for FRB Utilization

Mfg.
Primary proc.
Advanced proc.

-3.6*
- 3.4
- 4.0*

Correlation Between

FRB

Util. a n d H P - D e t r e n d e d

IP

0.81
0.83
0.79

NOTE: DF denotes the Dickey-Fuller test statistic. These statistics were derived from
regressions on logs of quarterly data from 1952 to 1992; four lags of the dependent variable
were included. One asterisk indicates that the null of a unit root was rejected at a critical level
of 0.05. The correlations were calculated on quarterly utilization rates from 1952 to 1992.

177

James E. Kennedy
TABLE 2.

Correlations with Producer Prices

Correlation between the PPI and:
Utilization

Manufacturing
Current
Lag 1
2
4
Primary Processing
Current
Lag 1
2
4
Advanced Processing
Current
Lag 1
2
4

IF

FRB

HP

- 0.04
0.03
0.07
0.05

0.19
0.21
0.19
0.12

0.36
0.35
0.31
0.16

0.00
0.08
0.11
0.07

0.27
0.26
0.22
0.11

0.42
0.39
0.31
0.14

- O.11
- 0.03
0.03
0.06

O.11
0.15
0.16
0.11

0.29
0.32
0.31
0.20

NOTE: The correlationswere calculatedon quarterlydata from 1952to 1992.

Correlations between Utilization Rates and Prices

Table 2 shows correlations at the quarterly frequency between inflation, as measured by the producer price index (PPI), and both output and
utilization. The correlations for manufacturing are based on the manufacturing PPI; the PPI for finished products was used for advanced processing
and the PFI for intermediate materials was used for primary processing. The
first column shows the correlations between the log-difference of output and
the log-difference of prices; the second and third columns show correlations
between levels of utilization and log-differences of prices.
One interesting result is that inflation almost always is uncorrelated
with current and lagged output growth. For example, the percent change in
manufacturing IP shows a contemporaneous correlation of -0.04 with the
PPI. Lagged IF generally shows positive but very small--correlations with
PPI inflation. Output growth therefore does not appear to be a reliable
indicator of inflationary pressures.
As is shown in columns 2 and 3, current and lagged values of both
FRB and HP utilization are correlated positively with PPI inflation. All of
178

An Analysis of Time-Series Estimates

the HP-PPI correlations are larger than the comparable FRB-PPI correlations. For example, in manufacturing the contemporaneous correlation between the PPI and FRB utilization is 0.19, whereas the P P I - H P utilization
correlation is 0.36.

Phillips Curve Regressions

This section discusses the results of expectations-augmented Phillips
curve regressions) 3 The dependent variable in these equations is the rate
of PPI inflation. Lags of inflation are included as regressors in order to
capture persistence that may arise from, for example, backward-looking expectations and nominal wage and price rigidities. The equations also included a constant, a d u m m y variable to account for the period of wage and
price controls in the early 1970s, and the PPI for crude oil to capture the
effects of the 1973 and 1979 oil price shocks.
Current capacity utilization also is included on the right-hand side.
The PPI series are stationary over the sample period. Because HP utilization
is stationary by design, it was logged, but not differenced, prior to estimation.
By contrast, because the FRB utilization series are borderline stationary, it
is not clear how they should enter the regressions. Equations estimated on
the log-difference of FRB utilization are reported in the tables; however,
the results were about the same when the log-level was used instead. 14
The regressions were estimated without restrictions on the 1952:192:4 period. The results are summarized in Table 3. For each industry group,
the first row shows the results of a regression that did not include a utilization
rate. The second row summarizes the results when the FRB utilization rate
was added to the null regression; the third row displays the results when the
FRB rate was replaced by the H P utilization rate.
For manufacturing as a whole, the H P utilization rate is somewhat
more significant than the FRB rate. For both advanced and primary processing the H P rate also is more significant. Nevertheless, it is important to
note that, on the margin, neither measure of utilization explains an appre13Forexamples,see Gordon (1982, 1985) and Stockton and Struckmeyer (1989). The original
specificationof the Phillips curve related wage inflation to the degree of slack in labor markets.
If the goal was to explain price inflation, a markup equation might be employed to extend the
argmnent from wages to prices. For some time, however, the Phillips curve has been thought
of as the relationship between unemployment and price inflation. Taking an extreme position,
Gordon (1988, 276) asserted that "wagechanges do not contribute statisticallyto the explanation
of inflation,with the profound implicationthat the aggregate supplyprocess in the United States
is characterized by a dichotomy:inflation depends on past inflation, not past wage changes."
14Theresults were much the same when the regressionswere estimated without trend terms.
The oil price variable and the wage-price control dummies each improved the fit of the equations, but did not materially affect the results of interest.
179

James E. Kennedy
T A B L E 3.

Regression Relationships between Inflation and Utilization

Industry
Manufacturing

Primary pro.

Advanced pro.

Sum bi
0.61
0.66
0.64
0.59
0.64
0.65
0.61
0.63
0.63

FRB Utilization

H - P Utilization

Coeff.

t-stat.

Coeff.

33.00

3.5

29.28

15.49

t-star.

22.30

3.8

24.97

4.6

18.64

3.3

3.9

1.5

Standard
Error
2.61
2.52
2.50
3.17
3.03
2.97
2.36
2.35
2.28

NOTE: The results are based on estimation of the followingequation:

Pt = ao + alOt + a2Oilt + ~ bie,-~ + 7Aut + "ch~+ et ,
where P denotes the log-difference of the PPI series; u denotes the log of either the FRB or
the HP utilization series, respectively; D is a set of dummy variables that capture the effects of
wage and price controls; Oil is the producer price index for crude oil, which is meant to help
explain unusual movements in the explanatory variables due to the oil price shocks in the 1970s;
a linear trend also was included. Prices were logged, differenced, and multiplied by 400 prior
to estimation; FRB utilization was represented as a log-difference and HP utilization was represented as a log. All of the regressions included 8 lags of prices, although the results were
about the same when only four lags were used.

eiable percentage of the variance in PPI inflation. For example, in the case
of manufacturing, the standard error of the null regression is 2.61 percentage
points; the addition of H P utilization reduces the standard error only 0.11
percentage point, or just over 4%.
These regressions also were estimated for disaggregated manufacturing industries (these results are not reported). The industry results were
similar to those reported above for the aggregate manufacturing groupings:
The H P rate generally was more correlated with current inflation than the
FRB rate. An interesting question is how the H P utilization series perform
relative to the FRB series in industries for which the primary source data
for the FRB estimates is physical product data. These industries include
textiles, paper, chemicals, steel mill products, and motor vehicles. In the first
three of these industries, the H P utilization rate enters the Phillips curve
regression much more significantly than the FRB rate. In the steel mill
products regression, each of the utilization rates is marginally significant, and
in the equations for motor vehieles neither of the utilization rates is signifi180

An Analysis of Time-Series Estimates

cant. In summary, the results indicate that even in the industries where FRB
capacity is rooted in physical product data the HP measures usually offer at
least as much, if not more, information to the explanation of current inflation
than do the FRB rates.

Tests for Granger Causalityfrom Utilization to Prices

A separate question is whether changes in utilization presage an acceleration in inflation. The significant positive correlations shown in Table 6
between lagged utilization and current inflation indicate that utilization does
tend to increase in advance of producer price inflation. The results presented
in this section ask whether lags of utilization contain information for prices
that is not contained in lags of prices; that is, whether utilization Grangercauses prices.
As shown in Table 4, during the 1952-92 sample period, neither FRB
nor HP manufacturing utilization contains a great deal of leading information
for the PPI. Both utilization measures Granger-cause prices in the advanced
processing industries; however, neither utilization rate Granger causes the
PPI for intermediate materials. However, the results are very sensitive to
the sample period. For instance, tests conducted on the 1960-92 and 196892 periods, shown in the middle and lower panels of the table, show significant Granger causality from utilization to prices in both manufacturing and
advanced processing. The tests do not indicate that primary processing utilization Granger causes the intermediate materials PPI in any of the sample
periods. In most of the tests, the F-statistic on HP utilization is larger than
that on FRB utilization, indicating that the HP series generally offer somewhat more leading information for inflation than the FRB series.

Results for Broader Price Indexes

Table 5 reports results for the consumer price index (CPI), the CPI
excluding food and energy (core CPI), and the GDP fixed-weight price index. The upper panel shows results of Phillips-curve regressions and the
lower panel results of tests for Granger causality. All of the regressions were
estimated on the 1962-92 period. As may be seen, the t-statistics on the HP
utilization rates are much larger than those on the FRB rates for all three
of these price indexes. The results in the lower panel show that Granger
causality from HP utilization to prices is much stronger than that from FRB
utilization to prices. For example, for the CPI the F-statistic for the HP
series is 9.95 that for the FRB measure is 7.58. The differences are even
larger for the core CPI and the GDP deflator. Note also that on this shorter
sample period, both the FRB and the HP rates appear to Granger cause the
PPI (the MSL of each of these tests is 0.02); by contrast, over the full sample
period, as discussed above there was much less evidence of Granger can181

James E. Kennedy
TABLE 4.

Resultsof Testsfor Granger Causalityfrom Utilization to

Prices
SIC

FRB Utilization

Industry

HP Utilization

F(U > P)

MSL

F(H > P)

MSL

1.45
0.65
3.20

0.21
0.63
0.01

1.73
0.70
3.81

0.15
0.60
0.01

2.81
1.06
3.89

0.03
0.38
0.01

3.13
1.29
4.82

0.02
0.28
0.00

3.04
1.41
3.94

0.02
0.24
0.01

3.08
1.52
3.91

0.02
0.20
0.01

1952-92
Manufacturing
Primary processing
Advanced processing

1960-92
Manufacturing
Primary processing
Advanced processing

1968-92
Manufacturing
Primary processing
Advanced processing

NOTE: The results are based on estimation of the following equation:

Pt = ao + alD~ + + a2APOILt +

b~et-, + 7Dut + 7h~ + et,

where P denotes the log-difference of the price series; u and h denote the FRB and HP utilization series, respectively; D is a set of dummy variables that capture the effects of wage and
price controls, and DPOIL denotes the log-difference of the PPI for crude oil. Prices were
logged and differenced prior to estimation; the FRB utilization rates were represented as log
differences; the HP rates were entered in the regressions as logs. All of the regressions included
8 lags of prices; the results were about the same when only four lags were used. The equations
were estimated on the indicated sample period. F(U > P) denotes the F-statistic for a test of
the null hypothesis that FRB denotes the F-statistic for a test of the null hypothesis that FRB
utilization does not Granger-cause prices; F(H > P) is for a test of the null that HP utilization
does not Granger-cause prices.

sality. To sum up, both utilization series show much more explanatory power
in the regressions on the broader price indexes than in those on the PPI.
This is true in both the Granger tests and the Phillips curve regressions. The
HP series are much more significant in these tests than the FRB series.

Out-of-Sample Simulations
A set of simulations were conducted in order to provide an additional
perspective on the information that capacity utihzation brings to bear on
forecasts of inflation. In the simulations, the forecasting performance of a
univariate equation is compared to regressions that included either FRB
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An Analysis of Time-Series Estimates

Regression Relationships between Broader Price Indexes and
Manufacturing Utilization
TABLE 5.

FRB Utilization
Industry

CPI

CPI, ex. food and

energy

GDPfixed-weight
price index

Sum bi
0.79
0.84
0.85
0.85
0.85
0.91
0.94
0.95
0.87
0.87
0.93
0.91

Coeff.

t-stat.

23.6

2.9

3.7

0.5

26.3

2.7

4.2

0.4

0.6

0.1

-11.6

-1.7

FRB Utilization
F(U>P)

CPI
CPL ex. food and
energy
GDPfixed-weight
price index
PPI, manufacturing

H-P Utilization Standard

Coeff.

26.1
25.2

24.5
23.6

15.2
17.3

t-stat.

Error

6.4
5.5

1.45
1.41
1.25
1.25

6.0
5.2

1.57
1.53
1.37
1.38

4.6
4.9

1.26
1.26
1.16
1.15

HP Utilization

MSL F ( H > P )

MSL

7.58

0.00

9.95

0.00

3.43

0.01

8.86

0.00

2.34
2.99

0.06
0.02

7.96
2.92

0.00
0.02

NOTE: See the notes to Tables 3 and 4.

utilization or HP detrended IP. Simulations were conducted for the manufacturing PPI, the total CPI, the core CPI, and the GDP fixed-weight price
index. Each equation included a constant, the current value of the PPI for
crude oil, and a wage-price dummy variable. Lag lengths, which varied for
each equation, were chosen so as to minimize the root mean square error
of the out-of-sample simulation.
The simulations were conducted as follows: First, the equation was
estimated through 1974:iv. Then, a forecast was calculated for 1975:i. The
equation was then estimated through 1975:i and a forecast was calculated
183

James E. Kennedy
TABLE 6.

Out-of-SampleSimulation Results

Simulation
Period

FRB Utilization

HP Utilization

Mean

Univariate
RMSE

Mean

RMSE

Mean

RMSE

0.2
1.4
0.0
0.3
- 1.6
-0.6

3.2
3.0
2.9
1.6
3.1
2.1

0.2
1.3
0.2
0.2
- 1.5
-0.4

3.2
3.0
2.9
1.6
3.1
2.0

0.1
1.4
0.2
0.1
- 1.6
-0.5

3.2
3.0
2.9
1.6
3.1
2.1

- 0.1

1.9

0.0

1.8

0.0

1.7

-0.3
- 0.4

1.8
1.3

-0.1
- 0.3

1.8
1.3

-0.2
- 0.4

1.8
1.2

Manufacturing PPI
1975-92
1978-79
1979-80
1983-84
1989-90
1991-92
Memo (1975-92):
Total CPI
CPI ex. food and
energy
GDP price index

NOTE: The simulations are described in detail in the text.

for 1975:ii. This was repeated through the end of the sample, giving a total
of 72 simulation results. The results are summarized in Table 6. We look at
the mean forecast error and the root mean square error (RMSE). Neither
of the utilization rates offers an improvement over the univariate equations
in forecasts of either the manufacturing PPI or the CPI excluding food and
energy. The inclusion of either the FRB or the HP rate provides some improvement in the forecast of the total CPI; inclusion of the HP rate lowers
slightly the RMSE for the GDP fixed-weight price index, but the FRB rate
does not offer any improvement in a forecast of this price index.

4. Conclusions
The results show that the HP utilization rates perform well relative to
the FRB series in terms of their ability to explain current inflation. The HP
rates are especially more potent in their ability to explain the broader price
indexes. The advantage of the HP rates is that they are essentially eostless
to produce, they are consistent over time and across industries, and the
estimates may be easily reproduced by users of the data. Certainly, however,
these findings do not suggest that the FRB capacity series should be replaced
with time-series measures. Rather, the results indicate that the time-series
estimates hold promise as an additional input into the FRB's method, especially for industries in which no physical capacity data are available. The
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An Analysis of Time-Series Estimates

HP estimates also may be a useful input in the FRB's estimates of capacity
for the years beyond the most recent benchmark data.
This paper considered an important but rather narrow criterion: the
ability of the respective utilization series to explain inflation. Other criteria
also should be examined. For example, we may want to see which set of
utilization measures brings the most information to a forecast of investment
spending or of nonfinancial corporate profts. In a recent article, Koenig
(1996) asked whether utilization Granger-causes output growth. He finds
that lagged FRB utilization does offer significant information in an equation
that included lagged output growth, lagged labor force utilization, and lagged
growth in the index of leading indicators. He also compares the predictive
power of FRB utilization to a time-series measure proposed by Beaudry and
Koop. Koenig's results suggest that the FRB and Beaudry-Koop measures
offer about the same amount of information to a forecast of output growth.
Received. August 1995
Final version: November 1996

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