Does Capacity Utilization Predict Inflation? A Wavelet Based Evidence from United States

This paper aims to test a causal nexus between capacity utilization and inflation in the United States for the period from January 1969 to June 2017. Given the non-validity of the constant-parameter linear model (i.e., standard linear Granger causality) in attendance of nonlinearities and structural breaks, we use wavelets to provide a more general picture of the link between the U.S. capacity utilization and U.S. inflation in both time and frequency domains. The findings indicate a positive co-movement between the variables, mainly at high frequencies (shorter term). In addition, we do find evidence of a significant bi-causal relationship between capacity utilization rate and inflation per different frequency, whereas standard linear Granger causality detects a unidirectional link from inflation to capacity utilization. In general, our findings suggest a notable implication for policy makers that are in contradiction to the view of recent scholars regarding deterioration in the inflation–utilisation nexus.