Output Gap and Inflation

Marketwatch details:

Output of the nation's factories, mines and utilities rose 0.7% in September after an upwardly revised 1.2% gain in August and a 0.9% increase in July, the Fed said. The 0.7% increase in output in September was stronger than the 0.4% gain expected by economists surveyed by MarketWatch. Manufacturing output rose 0.9% in September. Capacity utilization rose to 70.5% in September from a revised 69.9% in August.

Looking at the chart below, we see an improvement in the year over year decline in capacity utilization, which indicates less disinflationary pressure in the system.

BUT, Macro-man details why inflation may tick up before the level of capacity utilization increases:

However, it's probably worth touching on some small aspect of the debate, as behind the scenes it seems as if the same is happeneing at the Fed. Don Kohn's recent speech highlighted the large size of the output gap, a view largely echoed in last night's FOMC minutes. Yet at a recent St. Louis Fed conference, Bank president James Bullard offered a somewhat contrary view-namely that the collapse of the bubble has eradicated some of the productive capacity of the economy, thus rendering the output gap smaller than commonly believed.

And an example of how a decrease in the value of a dollar may play into the inflation/deflation debate (i.e. a weak dollar will make it more difficult to import disinflation from overseas):

While it's certainly the case that import prices from China are still down year-on-year, intriguingly, the quarterly change in import prices has returned to zero. In other words, there is no marginal deflationary trend in US import prices from China. If (or rather, when) domestic inflation in China starts to rise, courtesy of PBOC's helicopter money-drop, it seems reasonable to posit that US import prices from China will begin to rise.

Source: BLS