Productivity growth is slowing, just as it was when Burns headed the central bank, not accelerating as it did under Greenspan’s watch. Business output per hour excluding agriculture has risen at a 1.4% average annual rate since the recession ended in June 2009 as hiring has picked up while economic growth has lagged behind.
That result is in line with the 1.5% rate from 1973 to 1977 and less half of the 3% pace from 1996 to 2000, Labor Department data show. The post World War II average is 2.3%.
To understand why this is important, look at what happened to the U.S. in each of those periods.
In the late 1990s, increased worker efficiency allowed Greenspan to countenance a fall in the unemployment rate to a 30-year low of 3.8% in April 2000 as companies could pay employees more without having to raise prices. In the 1970s, a sudden downshift in productivity growth caught Burns by surprise and led to a rise in consumer prices of more than 10% after oil costs surged.
“There is a risk,” said former Fed Vice Chairman Alan Blinder, who served under Greenspan and co-wrote a book with Yellen about “the fabulous decade” of the 1990s. “You do have the possibility of replaying in the same direction what happened after 1973.”
That doesn’t mean the U.S. is about to experience a sustained rise in inflation, he added. “We’re a long way from seeing that.”
What it does mean is that Yellen and her Federal Open Market Committee colleagues must be a “little more cautious” about keeping short-term interest rates near zero in their pursuit of lower joblessness, said Blinder, who is now a professor of economics at Princeton University in New Jersey.
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Last month’s drop in the unemployment rate to an almost six-year low of 6.1% highlights the dilemma facing the Fed, said Stephen Stanley, chief economist at Pierpoint Securities LLC in Stamford, Connecticut. Joblessness is falling faster than the central bank expected while gross domestic product is expanding more slowly than its projections. Behind the discrepancy: slower productivity growth, according to Stanley. He now sees the Fed starting to raise interest rates in June 2015, instead of waiting until September of next year.
Inflation already is showing signs of accelerating. The personal-consumption-expenditures price index, the Fed’s favorite measure, rose 1.8% in May from a year earlier, compared with 1.6% in April and 1.1% in March, according to the Labor Department.
Chipotle Mexican Grill Inc. (CMG) is among companies boosting prices. “We really haven’t had any resistance” from customers, Steve Ells, co-chief executive officer of the Denver-based burrito chain, told Bloomberg Television’s “Surveillance” on June 27. The increase of as much as 6% will partly offset higher costs for ingredients and is Chipotle’s first in three years.
“We are facing a problem of rising inflation,” said Martin Feldstein, a professor at Harvard University in Cambridge, Massachusetts, and former chairman of the White House Council of Economic Advisers. The Fed is “probably going to respond too weakly, too slowly,” he added in a June 4 interview on “Surveillance.”
Long-term interest rates are “going to go a lot higher,” with the yield on the 10-year Treasury note eventually hitting 4%, as price pressures intensify and the Fed lags behind in its response, according to Joe LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. The note’s yield was 2.64% at 2 p.m. in New York on July 3, ahead of the July 4th U.S. holiday, based on Bloomberg Bond Trader data.
The Fed’s macroeconomic computer model recognizes that unexpected changes in productivity growth can affect inflation, said Michael Feroli, a former central-bank researcher who is now chief U.S. economist for JPMorgan Chase & Co. in New York. The question is whether policy makers will factor this into their decisions on interest rates.
“You could have, at least in the short run, a little bit of a policy mistake if they overestimate productivity growth,” he said. “If they’re wrong, you’re going to see it show up in faster inflation.”
Feroli changed his forecast of Fed policy after last week’s news of a further fall in joblessness. He now expects the central bank to begin raising interest rates in the third quarter of next year, instead of the fourth.