America’s labour productivity is rising—This should imply a higher neutral rate of interest and tighter Fed policy

Subscribe to enjoy similar stories. The US economy seems to be in the throes of one of its biggest bursts of productivity in decades, weighing on business labour costs and hastening disinflation. If artificial intelligence (AI) is partly the reason for the gains, then it’s plausible that we’re in the early days of durable improvements to efficiency.

And yet, the numbers are also shrouded in mystery and the US Federal Reserve should greet them caution rather than as a green light to keep lowering interest rates. American labour productivity, or non-farm employee output per hour, increased at a 4.9% annualized rate in the third quarter, the strongest since 2023, according to the Bureau of Labor Statistics. Excluding the bounce-back quarters around recessions, it was the second-strongest reading in two decades.

Meanwhile, unit labour costs plunged for a second consecutive quarter, dropping 1.9% after declining 2.9% in the April through June period. Taking them at face value, rising productivity and lower costs are worthy of celebration. America’s increasing efficiency is creating conditions for a continued slowdown in inflation that has been happening for three years even as the economy powers ahead and the stock market scales record highs.

And yet, no one can say for sure what’s behind the numbers, whether it will continue and what it means for interest rates. And that goes for Fed policymakers as well, who would do well to exhibit some humility in the months ahead. So is it AI? Maybe.

The most obvious explanation is often the right one. According the Census Bureau’s Business Trends and Outlook Survey, around 18% of US firms report having used AI in the past two weeks. That’s more than triple the adoption in early 2024.