MNI POLICY: Fed Leans Into Prospect Of Productivity Upgrade
MNI (WASHINGTON) - Federal Reserve officials are cautiously embracing the possibility that a resurgence in U.S. productivity will prove enduring, aiding their mission to keep inflation at bay without derailing strong economic growth.
The Fed would never rely on volatile trends in productivity to do its work for it, and certainly not to guide meeting-by-meeting decisions. But the persistent productivity gains have not gone unnoticed inside the central bank.
Policymakers see a number of possible underpinnings for the recent trend which, if sustained, could mean the country's growth potential is higher than prevailing estimates around 2%. These include a jump in new business formation, big investments in technology as well as a boost to labor force participation together with immigration and improved job-matching that helped offset any inflationary boost from higher wage costs.
Fed staff economists last month lifted their assessment of potential output growth after revised data showed productivity growth has been running at a 1.9% annualized pace post-pandemic, compared to the 1.4% pace in the five years previous.
NEWFOUND OPTIMISM
After the inflation surge that came with the recovery from the pandemic, Fed officials including Chair Jerome Powell thought a significant amount of "economic pain" would be required to bring it down. Instead, the economy kept humming along despite aggressive rate hikes.
The lasting nature of the benign economic backdrop is reinforcing optimism among policymakers that the productivity gains that emerged in the wake of Covid could be here to stay.
Minutes from the November meeting said that "some participants highlighted more durable factors, such as new business formation and investment, as well as the integration into the workplace of technological advances. A couple of participants discussed some of these recent trends, noting especially possible implications of the expanded use of artificial intelligence in the workplace."
Total factor productivity, a measure of how efficiently labor and capital are used, rose 1.3% in 2023, the Bureau of Labor Statistics said last week, nearly double the initial estimate and double the 2010-2019 period.
Investments in technologies including generative AI at a time when workers were scarce might be starting to pay off, some Fed officials believe. New business applications which surged during the pandemic have also remained elevated, and research this week from Census Bureau economists shows such an uptick significantly leads and is positively correlated with employment growth.
OPEN QUESTION
AI in particular holds the promise of a powerful boost to productivity lasting decades. While officials caution the size and timing of these effects are uncertain, the central bank is already engaged in trying to understand how AI will transform employment, business investment, payment systems and more.
Should the productivity boost last, the FOMC will grow more confident it can still cut rates and achieve its inflation target while preserving strong growth that benefits all. For now, that is a longer-run calculation. (See: MNI INTERVIEW: Higher Trend Growth Means More Fed Cuts - S&P)
"We would all prefer sustained high-productivity growth. Perhaps new business formations, capital deepening, a broader adoption of labor-saving automation technology, and AI have put the economy on a new higher-productivity path," St. Louis Fed President Alberto Musalem said in speech last week. "But whether productivity growth will remain high is an open question. In the meantime, it seems preferable to remain careful about relying on higher productivity growth to return inflation to target."