This morning the Federal Reserve released its May report on Industrial Production and Capacity Utilization.

The Fed's Index of Industrial Production measures the output of the nation's factories, utilities, mines, and oil and gas wells. Over the years, the Index has proven to be a reliable measure of the current state of the overall economy. It is one of the four indicators that the Department of Commerce uses in generating its monthly Composite Index of Coincident Economic Indicators.

Industrial production advanced 0.7 percent in May as it had in April. A portion of the increase reflected a spurt in electricity generation related to the unusual weather in May. Excluding the 3 percent gain in utilities production, the index of industrial production rose 0.5 percent.

As with many of the other indicators reported on here, you have to look at more than one month's change to get an idea of what's really happening. The period I use is a year. In the year ending in May, the Index of Industrial Production rose 3.2 percent. This compares with a year-over-year rise of 2.6 percent in April, a 1.3 percent rise in March, a 1.6 percent rise in February and a 0.1 percent rise in January. As I noted last month, in recent months the year-over-year growth in the index has been increasing.

Is economic activity expanding? You bet it is. You only need to look at the way the year-to-year index of industrial production has been growing in recent months.

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In today's release, the Fed also reported on industrial capacity utilization for May. Capacity Utilization measures the percentage of the nation's productive capacity that was employed during the month. From April to May this indicator rose 0.3 percent to a value of 83.2 percent.

In January of 1995, capacity utilization hit a peak of 85.1 percent. Between then and December 1995, the indicator declined steadily to a reading of 82.1. The January-through-May readings, as presented in today's report, were 82.4, 83.3, 82.6, 82.9 and 83.2. So, for the past five months, capacity utilization has been fluctuating in a narrow range and essentially moving sideways. If the economy continues to expand, then higher numbers for capacity utilization should lie ahead.

History has shown that capacity utilization and the unemployment rate are inversely related to one another. When economic activity expands, capacity utilization and employment expand, and the unemployment rate goes down. When economic activity contracts, the opposite is true. For the past 5 months the unemployment rate has been flat, with an average value of 5.6 percent. Economists regard an unemployment rate of about 5.5 percent as the "full employment" unemployment rate.

So, here's the situation: Over the past five months the economy has been expanding. But, during that same period, the nation's productive capacity level and the unemployment rate have been essentially unchanged. What's more, the unemployment rate is hovering just above the level that is generally regarded as the minimum practicably-attainable level. One conclusion that might be reached from all this is that the present expansion may be limited because there aren't enough workers out there to support additional job creation, and the fact that capacity utilization has not been able to advance during recent months seems to confirm this conclusion. It will be interesting to see how this all plays out in the months to come.

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In other news today, the preliminary value for the University of Michigan's consumer sentiment index for June became available. From May to June the index rose 4.4 points from 89.4 to 93.8. The more-important, but less-publicized, U of M consumer expectations index also gained significantly, jumping from 80.5 to 86.9. The expectations index is one of the eleven component indicators that makes up the Department of Commerce Composite Index of Leading Economic Indicators (LEI).

Byline: Lafferty (MF Merlin)