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The Fed Is Driving the Economy Without Knowing Its Speed Limit

Workers’ productivity since the fourth quarter of 2019 has grown at an annual rate of just 1.1%.


Celeste Noche for The Wall Street Journal

The economy can only go so fast without overheating. A big problem now is that nobody is sure just how fast that is.

Before the pandemic, the U.S. economy looked as if it had been stuck in a slow-growth mode for some time. Productivity gains—workers’ ability to get more done in a given amount of time—had diminished, while an aging population meant that the number of available workers was growing less quickly than in the past. As a result, most economists reckoned that potential gross-domestic-product growth, which measures how fast the economy can grow without inviting inflation, had fallen. The Congressional Budget Office estimates that potential growth in the decade ended in 2019 averaged 1.7% annually versus 3.1% during the 1990s.

The Covid-19 crisis has changed a lot of things, and one of the things it might have changed for the better is potential growth. New efficiencies developed during the pandemic seem as though they ought to deliver lasting productivity boosts, while the advent of work-from-home arrangements might over time increase labor supply.

Any increase in potential growth would count as welcome news for the Federal Reserve, since it wouldn’t have to try to slow down the economy quite so much as it would if potential is still low. And it would be welcome news for companies and U.S. workers, not just because it would lower the risk of the Fed sending the economy into recession, but because an economy that can grow faster can deliver more in the form of both profits and wages.

The problem is that there aren’t many indications of higher potential growth showing up in the data. The Labor Department reported that productivity, as defined by what the average worker produces in an hour, declined at a 7.5% annual rate in the first quarter from the previous quarter. Admittedly, these figures can bounce around a lot from quarter to quarter, and the first-quarter figure was likely distorted by some of the same factors that led to a negative GDP growth reading in the quarter.

Federal Reserve Chairman Jerome Powell in early May said the central bank approved a half-percentage-point interest-rate increase in an effort to slow inflation that is running at a four-decade high. Photo: Win McNamee/Getty Images

But since the fourth quarter of 2019, productivity has grown at an annual rate of just 1.1%. That compares with a 1.3% rate over the five years leading up to the pandemic. Meanwhile, the labor-force participation rate—the share of the working-age population working or looking for work—was 62.2% last month, which, though up from a year earlier, was still short of its February 2020 level of 63.4%.

Productivity is hard to measure, and the data can be subject to very large revisions. It is also possible that supply disruptions for semiconductors and other items are putting some temporary restraints on productivity. So it might be that the underlying trend in productivity has moved higher. It certainly seems as if changes such as fewer time-consuming in-person client meetings, restaurants moving to digital menus and the like ought to be making workers more efficient.

Stanford University economist

Nicholas Bloom

thinks that work-from-home arrangements, in particular, should improve the productivity outlook. Worker surveys he has been helping to conduct show that employers’ acceptance of work-from-home arrangements some of the time has risen postpandemic. If nothing else, that dramatically reduces the amount of time people spend commuting, which regardless of whether one considers time stuck in traffic as time on the job, should help boost worker output.

Mr. Bloom also thinks work-from-home arrangements could eventually boost labor-force participation. Older workers might put off retirement and instead downshift to part-time, for example, since putting in a half-day’s worth of work is a lot less time-consuming if it doesn’t include the hassle of going into the office.

It will take time to learn if that is actually true, however, just as it could take time for any of the hoped-for improvements in productivity to show up in the data. Until inflation comes under control and the job market stops getting tighter, any optimism the Fed might feel that the economy can grow more quickly will remain on hold.

Write to Justin Lahart at justin.lahart@wsj.com

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