The Fed runs the economy without knowing its speed limit

The economy cannot go so fast without overheating. A big problem now is that no one knows exactly how fast it’s going.

Prior to the pandemic, the US economy seemed stuck in slow growth mode for some time. Productivity gains – the ability of workers to do more in a given amount of time – had declined, while an aging population meant that the number of available workers grew less rapidly than in the past. As a result, most economists estimated that potential gross domestic product growth, which measures how fast the economy can grow without causing inflation, had fallen. The Congressional Budget Office estimates that potential growth over the decade to 2019 averaged 1.7% per year compared to 3.1% during the 1990s.

The Covid-19 crisis has changed a lot of things, and one of the things it could have changed for the better is potential growth. New efficiencies developed during the pandemic look set to deliver lasting productivity gains, while the advent of work-from-home arrangements could ultimately increase labor supply.

Any increase in potential growth would count as good news for the Federal Reserve because it wouldn’t have to try to slow the economy as much as it would if potential is still low. And that would be good news for American businesses and workers, not only because it would reduce the risk of the Fed pushing the economy into recession, but because an economy that can grow faster can produce more in the form of profits. and salaries.

The problem is that there aren’t many indications of higher potential growth in the data. The Labor Department said productivity, as defined by what the average worker produces in an hour, declined at an annual rate of 7.5% in the first quarter from the previous quarter. Granted, these numbers can bounce back a lot from quarter to quarter, and the Q1 number was likely skewed by some of the same factors that led to a negative reading for GDP growth in the quarter.

In early May, Federal Reserve Chairman Jerome Powell said the central bank had approved a half-percentage-point hike in interest rates in a bid to curb inflation, which is at an all-time high. high level for four decades. Photo: Win McNamee/Getty Images

But since the fourth quarter of 2019, productivity has grown at an annual rate of just 1.1%. This compares to a rate of 1.3% in the five years before the pandemic. Meanwhile, the labor force participation rate – the share of the working-age population working or looking for work – was 62.2% last month, which, although on the rise compared to the previous year, was still below its February 2020 level of 63.4%.

Productivity is difficult to measure and data is subject to very significant revisions. It is also possible that disruptions in the supply of semiconductors and other items will impose temporary constraints on productivity. It could therefore be that the underlying productivity trend has increased. It certainly looks like changes like reducing time-consuming in-person customer meetings, restaurants moving to digital menus and the like should make workers more efficient.

Stanford University economist Nicholas Bloom thinks work-from-home arrangements, in particular, should improve productivity prospects. Worker surveys he helped conduct show that employers’ acceptance of work-from-home arrangements has sometimes increased after the pandemic. At the very least, it drastically reduces the time people spend commuting, which whether or not the time stuck in traffic is considered work time should help increase worker output.

Bloom also thinks work-from-home arrangements could potentially boost labor market participation. Older workers might delay their retirement and switch to part-time, for example, because doing half a day’s work takes much less time if that doesn’t include the hassle of going to the office.

However, it will take time to find out if this is actually true, just as it might take time for any of the hoped-for productivity improvements to show up in the data. Until inflation is brought under control and the labor market stops tightening, any optimism the Fed might feel about the economy growing faster will remain on hold.

Write to Justin Lahart at [email protected]

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