Thoughts

August 02, 2024 | 15:07

U.S. Labour Costs: From Inflation Foe to Friend

Economist

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Chair Powell’s remark that the labour market is probably no longer a source of inflation pressure isn’t just grounded in a rising jobless rate. Sure, waning labour shortages have taken some steam out of wage growth, with employment costs running a more moderate 4.1% y/y and hourly compensation 3.2% in the second quarter, both down from around 5.0% a couple years ago. But lending a hand in the inflation fight is that the American worker is also producing more than before.

Labour productivity jumped last quarter and is now running 2.7% in the past year, a full percentage point faster than the half-century norm. Whether due to AI, increased automation, or past labour shortages pushing firms to rework processes, the productivity boom has become a source of disinflation pressure. When productivity improves, companies can pay more without squeezing profits or customers.

In fact, the cost of compensation per hour worked (or unit labour costs) rose just 0.5% in the past year, the lowest rate in nearly five years. If sustained, inflation would risk undershooting the 2.0% target. It’s no coincidence that the long stretch of low inflation between the financial crisis and the pandemic occurred when unit labour costs were also well behaved, though more due to weak wages than strong productivity (Chart 1).

Of course, productivity could lose its punch. Historically, it tends to move in short cycles, both up and down. One exception was the long streak of solid gains averaging 3.4% from 1998 to 2004 that was attributed to improved connectivity stemming from the internet. AI has the potential to spur an equally enduring boom in productivity, though questions remain about timing.

We always said that for the Fed to achieve a rare soft landing—especially this time given how high inflation was, how loose monetary and fiscal policies were, and how resilient the economy was—it would take a combination of skill, luck, and outside help to pull off. Productivity’s revival is akin to the timely return of a long-lost friend to lend a helping hand. And the longer this friend sticks around, the greater the chance the Fed will stick the landing by both subduing inflation and supporting growth.