Rising Productivity Could Save the US Economy From Persistent Inflation

Nonfarm labor productivity rose by an annualized 5.4 % in the 1st quarter, recovering from a 3.8% decline in the final quarter of 2020

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Nonfarm labor productivity in the U.S. rose by an annualized 5.4% in the first quarter of 2021, recovering from a 3.8% decline in the fourth quarter of 2020, according to a report published by the U.S. Bureau of Labor Statistics on Thursday.

Output increased 8.4% and hours worked increased 2.9%. Year over year, nonfarm business sector labor productivity increased 4.1%, reflecting a 1.1% increase in output and a 2.9% decline in hours worked.

Rising labor productivity has helped keep unit labor costs in the U.S. nonfarm business sector tame. They decreased an annualized 0.3% in the first quarter, following a 5.6% increase in the previous period. Hourly compensation went up 5.1% and productivity rose 5.4%. As a result, unit labor costs increased 1.6% over the last four quarters as hourly compensation rose 5.8% and productivity increased 4.1%.

Economists classify inflation into two categories, demand-pull and cost-push. Demand-pull inflation is caused by a spike in spending across the economy, not matched by the appropriate spike in aggregate supply. Cost-push inflation is caused by a shortfall in production due to rising raw material, energy and labor costs, not matched by a shortfall in demand.

At times, the two types of inflation can support and reinforce each other. For example, demand-pull inflation can feed into cost-push inflation, as rising prices can lead to wage hikes to compensate workers for the erosion of their real incomes. Higher wages, in turn, can fuel price hikes as producers try to pass the higher costs on to consumers.

That's how inflation turns from temporary to permanent, as was the situation in the 1970s.

Still, there's something that can save the economy from the vicious cycle of demand-pull to cost-push inflation: rising labor productivity. Instead, it can mitigate rising wages and keep labor costs under control, as seems to be the case so far with the current economic recovery.

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