Industrial Production & Capacity Utilization Web address: Industrial Production (IP) Index: IP covers nearly everything produced in the U.S. (20% of the economy) for manufacturing (82%), mining (8%), electric utilities (10%) and gas industries. Does not include output from agriculture, construction, transportation, communications, and service industries. Measures changes in the volume of goods produced (does not take price into account) IP corresponds to real GDP (close relationship between  IP and  GDP) Manufacturing is most cyclically sensitive part of economy, follows the ups and downs of the business cycle. Manufacturing activity is highly sensitive to changes in interest rates and aggregate demand. Good forecaster of manufacturing employment, average hourly earnings and personal income IP data has 2 formats: Supply Side: Output by industry (manufacturing, mining, utility) Demand Side: Type of product, (consumer/business/intermediate goods and materials) Real GDP growth estimator = 3-month  IP/IP Nominal GDP/Factory Sales/Manufacturing Revenues Growth estimator = (3-month  IP/IP) x (3-month  CPI/CPI) Capacity Utilization (CU): Present production divided by maximum potential production capacity 81% long-run average Measure of spare capacity/slack at factories, mines, utilities. Leading indicator of business investment spending and inflation pressures. High CU => rising investment spending and hiring, shortage of vendor parts, higher prices Low CU => low investment spending and hiring, surplus of vendor parts, lower prices. Follows the ups and downs of the business cycle. CU = 82-85% => production bottlenecks => rising producer prices High IP/CU => fast growing economy => rising profits => rising stock prices => production bottlenecks => rising inflation => rising interest rates => falling bond demand => fast growing economy => rising demand for dollar => rising exchange rate

Full capacity = 82-84%

Liquidity Preference Analysis Derivation of Demand Curve 1.Keynes assumed money has i = 0 2.As i , relative R E on money  (opportunity cost of money  )  M d  3.Demand curve for money has usual downward slope 4.QD M = f(i; Y, P) Income Effect:  Y =>  QD M at each i (D M  )  Y =>  W =>  D M as medium of exchange and store of value Price Level Effect:  P =>  QD M at each i (D M  ) People care about purchasing power of money, real money balances = X = M/P

M x V = P x Y M/M + V/V = P/P + Y/Y P/PM/M + V/V - Y/Y If V/V = 0, Then P/PM/M - Y/Y If  M/M >  Y/Y Then  P/P > 0 If  M/M =  Y/Y Then  P/P = 0 Milton Friedman: “Inflation is everywhere and always a monetary phenomenon” Equation of Exchange (identity) Velocity of Money = V (rate of money turnover) (link between M & PY)

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Hoarding money => deflation Austerity => stagnation/deflation Deflation => rising purchase power of dollar Deflation => lower wages => rising debt burden Deflation leads to: Households postpone spending Rising real interest rates Rising debt burdens 2.5% Target

Taylor rule A rule developed by John Taylor that links the Fed’s target for the federal funds rate to economic variables. Federal funds target rate = Current inflation rate + Real equilibrium federal funds rate + (1/2) x Inflation gap + (1/2) x Output gap Inflation targeting Conducting monetary policy so as to commit the central bank to achieving a publicly announced level of inflation.

Consumer Confidence/Sentiment Index ( Real Time Measures of Consumers Attitudes on Economy, Personal Finance, and Future Spending) Web: Web: Minor revisions Happy consumers are good for business so index is useful for predicting consumer spending. Unfortunately, the relationship between confidence index and spending is not a close one. Difficult to predict how humans will behave. Sales are the best method of measuring consumer confidence. A six month moving average of confidence is a better indicator of future household outlays. Index is important during economic turning points. Better at forecasting recessions than recoveries. Consumer confidence Index polls 5,000 new households, the survey has 5 questions with emphasis on labor market conditions - which can lag the economy Consumer Sentiment Index polls 500 new and continuing households (the rotating interview strategy is 60% new and 40% second time interviews => less erratic index), 50 questions with emphasis on financial and personal income expectations which is a driving force behind consumer spending => better leading indicator Market Analysis: Bonds:  Confidence =>  borrowing/spending =>   P/P =>  D Bonds =>  i Bonds Stocks:  Confidence =>  borrowing/spending =>   Y/Y =>  profits =>  P Stocks Dollar:  Confidence =>  borrowing/spending =>   Y/Y =>  i Bonds =>  dollar