Lessons from today’s GDP report: Long-expected rebound in productivity finally seems to be happening, and no reason for Fed to raise rates in their next meeting
The Bureau of Economic Analysis (BEA) reported this morning that gross domestic product (GDP—the widest measure of economic activity) grew at a 2.6 percent annualized rate in the last quarter of 2017. This was down slightly from the 3.2 percent growth rate of the third quarter of 2017.
Today’s data also lets us examine how the economy grew over the year that ended in December 2017. Between the end of 2016 and the end of 2017, the economy grew by 2.5 percent. This is a faster rate of growth than what prevailed in either 2015 (2.0 percent) or 2016 (1.8 percent), but it is far from unprecedented. Growth was faster in both 2013 and 2014, for example (2.7 percent growth in both of those years).
Importantly, the recent pickup in GDP growth is largely the result of faster productivity growth. Employment growth actually slowed in 2017 while output growth rose, which implies a pickup in productivity (the amount of economic output generated in an average hour of work). As I wrote almost a year ago, this pickup in productivity growth should not come as a surprise—productivity growth has been extraordinarily slow in recent years but it generally reverts to long-run averages. Further, the source of recent productivity growth weakness was clear—it was a continuing casualty of the enormous shortfall of demand caused by the Great Recession and its subsequent slow recovery. As the economy worked off this demand shortfall, it was always quite likely that a rebound in productivity growth would follow.
A key prediction made in that earlier paper was that the productivity rebound would likely be driven by a pickup in business fixed investment. When unemployment was extraordinarily high for years, businesses had little incentive to spend money to replace workers with capital equipment, because workers were cheap and plentiful. As the labor market tightens and workers became a bit harder to find and a bit more expensive (so far, however, just a bit more expensive), it is natural that businesses would lean harder on investing in plants and equipment rather than just hiring more people to boost output. This is exactly what happened in 2017: business fixed investment grew at its fastest rate since 2014.
The rebound in productivity growth is most welcome. Productivity provides the ceiling on how fast living standards can rise. Rapid productivity growth is a necessary, if not sufficient, condition for broad-based growth in incomes. Yet it is clear that there is nothing unexpected about this rebound in productivity, and it obviously was not driven by the recent GOP tax bill, the Tax Cuts and Jobs Act (TCJA). Today’s GDP report is about data collected before the TCJA was even passed, and most of the happier trends in today’s data were long-predicted.
Finally, today’s GDP report is another sign that the Federal Reserve should be extraordinarily cautious about shifting monetary policy in a more contractionary direction. Core price inflation (excluding volatile food and energy prices) continues to be far below the Fed’s 2 percent target (core prices rose just 1.5 percent over the past year). The uptick in growth and productivity has been long-awaited and should be welcomed by the Fed, not tamped down with interest rate increases.