Lower productivity points to slower growth and higher inflation

Today we learned that productivity fell at a 2% annual rate in the fourth quarter of last year. From a peak of 5.6% in 2009, it is now up only 0.6% in the past year. This fits with the slowdown in growth in the past two years—companies have squeezed about as much out of existing resources as they can. Without a faster pace of hiring and more investment in productivity-enhancing equipment, technology, and training, the economy's growth is going to be constrained to the current growth rate in jobs plus productivity gains of maybe 1% a year, and that in turn suggests we could see only 2-2.5% annual real growth going forward.

The above chart compares the 2-yr annualized growth of productivity (to minimize the typical quarterly volatility of this series) to the year over year change in the GDP deflator, the broadest measure of inflation. There is a relative strong tendency for the two to be inversely correlated. Strong productivity tends to coincide with low inflation, and weak productivity gains with higher inflation. If the bloom is indeed off the productivity rose for the time being, then this chart suggests that we could see somewhat higher inflation in coming years. 

Looked at another way, the decline in productivity means that unit labor costs are rising and could now begin to feed through to higher prices.