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Slowing productivity growth in the U.S. economy
may actually be beneficial to restraining future
inflation.
Although the connection between productivity,
economic growth and inflation is extremely difficult to
quantify due to the fluctuating nature of these
measurements, perhaps the current slowdown in the
growth rate of productivity has a silver lining. You see,
sometimes the economy needs to catch its breath.
Productivity’s influence on inflation pressures first
came center stage in October 1996. At the time, then
Federal Reserve Chairman Alan Greenspan disrupted
the status quo in economic theory during a speech
entitled “Technological Advances and Productivity” by
suggesting that increasing productivity rates in the
U.S. economy may be somehow containing measured
inflation. Four years later, then Federal Reserve
Board of Governors member Laurence Meyer, in his
speech, “The New Economy Meets Supply and
Demand,” challenged whether the new economy was
indeed rewriting economic dogma. He convincingly
detailed that a tectonic shift upward in measured
productivity levels arguably gave rise to the now
widespread belief amongst investors that trend real
economic growth could shift upward from 2½ to 3
percent to 3½ to 4 percent. But his biggest headline,
revealed later in the speech, was all but lost in the
press reports. Mr. Meyer’s relatively groundbreaking
conclusion suggested that yes, an upward shift in
productivity is a beneficial development; however, it
might also harbor an unintended consequence—
higher inflation.
Seven years later and the debate continues. In the
ensuing years, more than one member of the Federal
Reserve Board of Governors, Federal Reserve staff
and branch economists, along with a horde of
academics have weighed in on the question: Can
short-term shifts in productivity foster inflationary
pressures?
The consensus answer is yes.
If the increase in worker productivity translates
into disproportionate increases in aggregate demand
relative to aggregate supply, the result may be a
temporary increase in the prices paid. I use the word
temporary in that the research clearly concludes that
productivity-induced demand increases do not endure
for long periods unabated. Ultimately, supply
increases act to diminish upward price pressures.
All of which raises some important considerations
with respect to the current economic backdrop. You
see in that measured productivity in the U.S. economy
rests at the lowest year-over-year rate since 1995,
some economic pundits express concerns about
slower growth and rising inflation setting the stage for
a period of stagflation. However, as I see it, a decline
in the growth rate of measured productivity—after
years of steady increases (1996-2005)—is not a
harbinger of stagflation but instead presents a
welcome change of events enabling the economy to
catch its collective breath.
This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its
accuracy. The forecasts and opinions in this piece are not necessarily those of Van Kampen, and may not actually come to pass. Information
in this report does not pertain to any Van Kampen product and is not a solicitation for any product.
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