Productivity growth is not helping the inflation fight
|Summary
Weak productivity growth remains one of the many headwinds to the Fed's efforts to corral inflation back to target. Nonfarm labor productivity declined at a 2.7% annualized rate in Q1 and 0.9% over the past year. Unit labor costs picked up to a 6.3% annualized pace over the quarter, checking some of the recent optimism that wage pressures are beginning to ease in a meaningful way.
Doing less with more
Timing is everything, especially when it comes to short-term measures of productivity. A near stalling of production in Q1 coincided with a pickup in hours worked, leading to nonfarm labor productivity contracting at a 2.7% annualized rate in Q1. The decline in part reflects noise from the often lumpy path of both output and hiring over short intervals. Hours worked accelerated over the quarter amid the surge in Q1 hiring, while output growth slowed as businesses tapped into inventories to meet demand.
However, the drop in Q1 labor productivity also reflects the typical cyclical hangover from demand recovering faster than employment, with the eventual catch up in hiring depressing output per hour worked. This dynamic was on full display in 2022, which matched the worst year for productivity growth (1974, with a drop of 1.7%) in records dating back to 1948. The short-term trend is not looking quite as dire, with productivity on a year-over-over basis improving to a decline of "just" 0.9% (chart). However, through the ups and downs of the shutdowns, re-openings and restaffing efforts since the start of the 2020, labor productivity has grown only 1.1% on an annualized basis—worse than the much bemoaned 1.4% pace through the past economic cycle.
The problem with poor productivity growth is that it means higher unit labor costs (ULCs), which can drive inflationary pressures. Unit labor cost growth rebounded to a 6.3% annualized pace in Q1. Like productivity, the year-over-year pace is getting slightly less egregious, but at 5.8% it is still frighteningly high for a Fed aiming to get inflation back to 2% (chart). Although ULCs are more volatile than other measures of labor costs, their continued menacing pace adds to last week's Employment Cost Index in dampening the nascent optimism that wage pressures are beginning to ease in a meaningful way. Inflation's road back to 2% continues to look long as a result.
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