Productivity Gains and Deceleration in Unit Labor Costs Temporarily Reduce Concern about Inflation

Productivity of the U.S. economy grew 4.9% in the third quarter after a 2.2% increase in the prior quarter. The significant gain in productivity reflects the 3.9% jump in growth of real GDP in the third quarter. Productivity gains and declining unit labor costs provide solace to a central bank concerned about inflation. But the outlook is less promising because projections of weak GDP growth suggest that similar gains in productivity are unlikely.

In terms of implications for Fed policy, the 0.2% drop in unit labor costs, which puts the year-to-year change at 4.3%, reduces the risk of inflationary pressures because unit labor costs moved up 5.1% in the second quarter (see chart 2). The Fed continues to present a hawkish stance about inflation, which is justified in the current environment of rising energy prices and a weak dollar. However, the recipe to correct a weak dollar runs counter to the solution for weak economic growth. Chairman Bernanke??™s testimony of November 8 should offer additional insights about the Fed??™s latest view about this predicament.

There is an interesting detail to note in this report. The magnitude of the gain in productivity in the third quarter is noticeably larger than the increase implied by the hours and output data already published. The main reason for the discrepancy is the number of worked in the productivity report shows a 0.5% decline due to a drop in hours of the self-employed whereas the hours worked information published in the employment report posted an increase (see chart 3).