Fed’s ‘Golden Path’ to Soft Landing Aided by Productivity Boom

Productivity growth has averaged 3.9% over the past three quarters, more than triple the rate seen in the decade prior to the pandemic.

Pedestrians near the New York Stock Exchange (NYSE) in New York.

Wall Street economists are looking for the post-Covid boom in productivity to continue, which would sustain strong growth without a pickup in inflation. Federal Reserve officials are intrigued by the idea—but a little bit skeptical.

Productivity growth has averaged 3.9 percent over the past three quarters, more than triple the rate seen in the decade prior to the pandemic. When workers are more efficient, firms can generate more money to raise wages without charging higher prices, so monetary policy can be a bit less concerned about inflation.

However, productivity figures—which the Bureau of Labor Statistics (BLS) measures as output per hour—tend to be volatile. So the recent trend, while encouraging and supportive of a soft landing, has led Fed officials to be cautious in their optimism.

“I got my fingers crossed that that continues,” Chicago Fed President Austan Goolsbee said Wednesday. The “shockingly good” trend has supported wages being higher and the economy leading to a “golden path” of continued growth and low inflation, he said.

The longer-run productivity trend may be running “modestly higher” or around 0.2 percentage points more than pre-Covid, Richmond Fed President Thomas Barkin estimated this month, adding he hopes that it turns out to be more.

“For the past three or four quarters, productivity has been quite strong,” Barkin said. “But I don’t think it’s high enough for me to conclude that we’ve gone to some different productivity paradigm. But if we have a few more quarters that are like the last few quarters, I’ll change my mind on that.”

A tight labor market, with the unemployment rate running below 4 percent for the past two years, has encouraged employers to find ways to boost sales without more hiring and raises “the possibility that trend productivity has moved higher,” the Cleveland Fed’s Loretta Mester said.

Policymakers say they haven’t yet achieved the level of confidence they need on inflation to cut interest rates. Minutes of their January meeting will be released tomorrow.

2023 Productivity Boom

While Wall Street has been focused on how artificial intelligence (AI) and innovations such as ChatGPT will drive efficiencies, lifting technology stocks to record highs, the 2023 boom resulted from more mundane factors. One of those is simply an economy at full employment, with workers gaining experience and skills.

Another element is investments from Joe Biden’s administration in plants and semiconductors, as well as spending from the Inflation Reduction Act, according to Employ America, a think tank that supports pro-labor policies. The group also said the healing of supply chains that were disrupted during the pandemic boosted productivity.

“We haven’t had non-recessionary gains in a sustained manner since the 1990s,” said Skanda Amarnath, executive director of Employ America. “There are good reasons why this can continue.”

Back then, the adoption and widespread use of personal computers and the internet generated higher productivity, and then-Fed Chair Alan Greenspan was comfortable with faster growth without fearing that it would accelerate inflation. That was a prescient—and controversial—call made well before his colleagues that resulted in his being nicknamed “The Maestro.”

Now-Chair Jerome Powell, who has cited his predecessor’s leadership admiringly in the past, has been cautious in his assessment of productivity. The shift to remote work “doesn’t seem like it’s a big productivity increase,” and gains from AI would take time to play out, he said in a January press conference.

The Fed’s official forecasts share that conservatism, predicting long-term growth of around 2 percent, which suggests a productivity rate of around 1.5 percent with a labor force growth of around 0.5 percent. And assuming stable inflation, higher productivity will boost wage gains, which workers have been trying to hold onto since peaking in 2022.

A step up in productivity could lead to a “roaring 2020s” for economic growth, said Ed Yardeni, president and founder of Yardeni Research. He estimates that productivity might increase 2.5 percent or more annually for the rest of the decade—much faster than the Fed’s estimates.

What Companies Are Saying …

Central bankers are likely to be slow to embrace the idea of higher productivity lasting because a misstep with too easy policy would be costly, said Vincent Reinhart, chief economist at Dreyfus and Mellon. “It’s an open question” how long higher efficiency will continue, said Reinhart, who was a top adviser to Greenspan. “If you are wrong, you would let inflation persist too long.”

Beyond the near-term trend, some economists are optimistic that AI could support a new leg of productivity growth. But the pattern in the past has shown it takes several years, or even decades, for new technologies to translate into corporate efficiency gains.

More optimistic investors say it’s only a matter of time. The AI potential is “massive,” said Rebecca Patterson, former chief investment strategist at Bridgewater Associates. That could “double productivity growth in the U.S., which would be a major lift for GDP.”

 

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