Deutsche Bank Sees Slow Productivity Growth Ahead

        By David Harrison
        The U.S. could be in for a stretch of low productivity growth, which would have the counterintuitive effect of tightening the labor market, raising wages and forcing Federal Reserve officials to raise rates more rapidly than they otherwise would, says a new analysis from a trio of Deutsche Bank economists.
        But higher wages would also push up inflation, which means we would hit the central bank's 2% inflation target sooner than anticipated. That, the economists note, would likely mean that the Fed would end up with a slightly lower federal funds rate than anticipated, once the process of tightening is completed.
        "An outlook for slower productivity growth, if correct, has conflicting implications for markets depending on the time horizon considered: slower productivity growth likely means an earlier and more rapid ascent of fed funds rate during the initial stage of normalization, while at the same time arguing for a lower terminal fed funds rate," argue Peter Hooper, Matthew Luzzetti and Torsten Slok of Deutsche Bank.
        The report suggests Fed policy makers may have taken an overly rosy view of future productivity growth. The central bank's March projections assumed annual inflation-adjusted growth of slightly above 2%, in line with the trend over the past three years. But they also anticipate the decrease in unemployment will moderate or stall. That would imply a significant bump in productivity. A separate report from the consulting firm IHS on Tuesday anticipated long-term growth in the U.S. of 2.3% a year. The Fed is set to release updated economic projections Wednesday afternoon.
        "To hold unemployment unchanged in the face of 2.5% GDP growth and no change in labor-force participation, nonfarm business productivity would have to be growing at nearly 2% annual rate, more than a full percentage point above its recent pace," the Deutsche Bank economists write.
        Productivity growth has been sluggish in recent years, for reasons economists are debating.
        For the Fed's projections to come true, businesses would have to ramp up capital investment. To get to 2% potential growth within three years, growth in capital expenditures would have to average 8.4% a year, the report says. It would take a sustained expenditure growth of 6.23% a year to get there within five years, a period Deutsche Bank says is more "reasonable."
        The big unknown here is innovation, which could give overall productivity a jolt without such an investment in capital expenditures. But innovation growth is unpredictable and volatile and therefore difficult to build into economic projections.
        Barring any new technological advance or a sudden upsurge in business investment, we could be in for lower potential growth and tighter labor markets. Simply put, it would take more people working more hours to grow at a slower pace.
        Related reading:
        Goldman Sachs and J.P. Morgan Can't Agree Why the Economy's Productivity Has Slumped
        Whatever Happened to 4% Growth? And Could Jeb Bush Bring It Back?
        U.S. Manufacturers Temper Expectations for Hiring and Investment
        (END) Dow Jones Newswires

        June 17, 2015 05:32 ET (09:32 GMT)

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