What It Measures
Capacity Utilization measures what percentage of the economy's total productive capacity is currently being used. It is calculated as:
Capacity Utilization = (Actual Output / Potential Output) × 100- The measure covers the same sectors as Industrial Production:
- Manufacturing (factories)
- Mining (oil, gas, minerals)
- Electric and gas utilities
A reading of 80% means the industrial sector is operating at 80% of its maximum sustainable output.
Why It Matters
Inflation Predictor: High capacity utilization (above 80%) suggests potential inflationary pressure as businesses have less room to expand and may raise prices.Investment Signal: Low utilization discourages new capital investment; high utilization encourages it.Fed Watch: The Federal Reserve monitors capacity utilization as an indicator of economic slack and potential inflation.Recession Indicator: Sharp declines in utilization often accompany or precede recessions.
How to Interpret
Above 80%: Economy running hot, potential inflation pressure, capacity constraints
75-80%: Healthy utilization, room for growth without inflation
70-75%: Moderate slack in the economy
Below 70%: Significant excess capacity, deflationary pressure, recession risk
Watch for sustained trends rather than single-month readings, as the data can be volatile.
Key Levels to Watch
| Level | Interpretation |
|---|---|
| Above 82% | Potential inflation pressure, capacity constraints |
| 78-82% | Healthy utilization with room for growth |
| 75-78% | Some slack in the economy |
| 70-75% | Significant unused capacity |
| Below 70% | Severe recession levels, major excess capacity |
Historical Context
Capacity utilization averaged around 80% from the 1970s through 2000s. It plunged to 66.7% during the 2009 recession and 64.2% during the COVID-19 pandemic (April 2020), both representing severe underutilization of productive capacity.
Limitations
- Capacity utilization has some limitations:
- "Capacity" is estimated and can be revised
- Does not capture service sector utilization
- May lag actual economic conditions
- Technological changes can affect potential capacity estimates