Capacity utilization rates and unemployment rates: are they complements orsubstitutes in warning about future inflation?

This research examines capacity utilization as a measure of economic slack in the US economy. Many macroeconomists have questioned the use of capacity utilization as a measure of economics slack on several fronts. The first i ssue revolves around the definition and accuracy of measurement of the capa city utilization rate in the US economy. Since this research use existing F ederal Reserve measures of capacity utilization no insights into the defini tion and measurement issues are offered other than the fact that a consiste nt role is found for two different Fed measures of capacity utilization in explaining inflation. The second issue effectively involves the concern as to robustness of the link between the capacity utilization rate and inflati on. It was found that there is indeed reason for the Federal Reserve to tak e note of changes in capacity utilization when trying to determine its poli cy position with regard to inflation. Clearly, the high capacity measure de veloped in this research offers distinct information about the inflation pr ocess. The third issue raises the question as to whether the capacity utili zation and unemployment rates are complements or substitutes in the inflati on equation. Both rates tend to provide similar information regarding price changes at low levels of aggregate resource usage. However, as resource us age in the economy becomes increasingly close to its maximum potential, the labour market impact on inflation, as capture by unemployment rate measure s, is distinctly different from that of capacity constraints. Finally, if t he capacity utilization rate is indeed a useful measure of inflationary pre ssure, is there a threshold level of the capacity utilization rate above wh ich policymakers should become particularly concerned about the potential o f accelerating inflation? It was found that across two measures of inflatio n, the widely discussed capacity threshold level is in the 84-85% range.