A significant surge in labour productivity within the United States economy is presenting a complex puzzle for the Federal Reserve. While helping to curb inflation, this efficiency boom might also signal that monetary policy is currently too loose, potentially requiring higher interest rates than anticipated.
The Productivity Puzzle and Its Disinflationary Impact
Recent data from the US Bureau of Labor Statistics reveals a robust acceleration in American economic efficiency. Non-farm labour productivity increased at a striking annualized rate of 4.9% during the third quarter, marking the strongest performance since 2023. Excluding periods of post-recession recovery, this stands as the second-best reading in the past twenty years.
This surge in output per hour worked has had a direct and powerful effect on business costs. For the second quarter in a row, unit labour costs have fallen sharply, declining by 1.9% after a 2.9% drop in the April-June period. This dynamic is creating a favourable environment for continued disinflation, allowing the economy and stock market to grow while price pressures ease.
AI's Ambiguous Role in the Efficiency Boom
The driving force behind this productivity jump remains shrouded in some mystery, with artificial intelligence being a prime suspect. Adoption rates are climbing rapidly; a Census Bureau survey indicates that around 18% of US firms now report using AI in any business function, a figure more than triple that of early 2024.
Research underscores AI's potential as a game-changer for specific sectors. Studies have shown human-AI teams in marketing achieving productivity gains of 73% over all-human teams, while AI-assisted software developers completed 26% more tasks. However, the benefits are not universal. In more traditional sectors, like transportation, AI tools provided only a modest 7% boost to lower-skilled workers and negligible help to high performers, highlighting that its impact is highly dependent on context and existing human skill levels.
Policy Implications: A Higher Neutral Rate Calls for Caution
The critical implication for the Federal Reserve revolves around the neutral rate of interest—the theoretical level that neither stimulates nor restrains the economy. While lower unit labour costs are disinflationary, a sustained productivity boom typically increases demand for investment capital and raises the economy's potential growth rate. This combination can push the neutral rate higher.
If policymakers focus solely on cooling inflation from lower costs and ignore this rising neutral rate, they risk keeping financial conditions too accommodative. This could inadvertently fuel asset bubbles or re-ignite inflationary pressures later. The dilemma is pronounced: Fed Governor Stephen Miran recently advocated for significant additional rate cuts this year, predicated on current policy being restrictive. Yet, a separate New York Fed survey showed consumer inflation expectations for the next year rising to 3.42%, moving away from the central bank's 2% target.
The inherent uncertainty surrounding both productivity trends and the neutral rate dictates a cautious approach. The Fed must proceed with humility, gathering more data on the labour market, inflation, and the durability of efficiency gains before committing to a definitive policy path. In what may be the early phase of a productivity revolution, patience is a vital virtue for central bankers.
