Inflation and unemployment certainly serve as the headline numbers that drive Fed policy. Still, a recent Bloomberg article suggests that Yellen is increasingly evaluating the economy’s productivity statistics as the Fed gears up for a policy change. That said, productivity growth derives most of its policy importance from its effect on the price level.
Without productivity growth, increases in demand for an economy functioning at or near its supply capacity will apply upward pressure on the price level. While recent growth in the labor force might ease some supply pressures, ultimately the economy will start experiencing some upward trending inflationary forces without increases to productivity.
The Fed looks at both TFP and labor productivity statistics. I do wonder if one or the other remains more pertinent to inflation. Wage growth certainly is key, but might isolating labor lead to a less direct relationship with the aggregate economy’s price level?
http://www.bloomberg.com/news/articles/2015-02-20/yellen-confronts-economists-ignorance-as-she-weighs-higher-rate
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The Bloomberg article talks about innovation as a “murky” influence yet an important factor for measuring productivity. Robert Gordon clearly believes that the third industrial revolution, as we have spoken about, does not have much expansion power while other economists such as Erik Brynjolfsson have a more optimistic view of technological innovation. I wonder when it will become apparent that productivity growth is closer to 1% or 3% and if it is on the higher end will we be able to definitively look at it as a result of technological innovation?
If we look at the productivity series in FRED, it is clearly very noisy and in the short run correlated with labor and capital utilization (which in principle we should be able to correct for using standard regression techniques, though in practice “utilization” is hard to measure so that doesn’t help us much). That means we will only have a handle on the trend long after (years after!) the decisions of Fed and other policymakers.
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