When Federal Reserve policymakers gather this week for their final meeting of the year, the focus will be on the anticipated 25 basis point interest rate cut and the policymakers' latest outlook on the economy and interest rate prospects.

However, influencing these discussions and the long-term path of MMF is an emerging debate on productivity, and what level of output growth can be reached without exceeding the economy's capacity and avoiding inflation surpassing the Federal Reserve's 2% target.

As is well known, the annual growth rate of U.S. workers' output per hour can fluctuate significantly in the short term, but the long-term trend seems stable. Since 2019, the annual growth rate of U.S. workers' output per hour has climbed from about 1.5% over the previous decade to an average of about 1.8%, and recently even higher.

Over time, even such small improvements can become significant, and this momentum occurs in the early days of the spread of AI tools, which may enhance this improvement.

Its effects could be far-reaching, including the trajectory of federal debt and the impact of the upcoming Trump administration policies. For example, in an environment of continuously improving productivity, addressing labor shortages caused by immigration may be easier to absorb. When elected Vice President JD Vance seemed to foresee this situation, he discussed last summer in an interview with the New York Times about McDonald's workers being replaced by kiosks and moving on to higher-paying jobs.

U.S. productivity growth may surpass long-term trends.

The growth of U.S. productivity shows enough persistence that confidence in a U.S. productivity model putting the country in a 'low-growth' state has almost completely shifted from nearly 100% to less than 60%.

It is still too early to say if there is a real shift, but it certainly seems more likely, said James Kahn, an economics professor at Yeshiva University and former vice president for research at the New York Fed.

"There is reason to be cautiously optimistic," wrote John Fernald, an economics professor at INSEAD, in a recent report published by the San Francisco Fed, where he previously served as an economist. This is one of the more influential voices in the Federal Reserve recognizing the limited but important issues surrounding productivity, and Fernald doubts that productivity growth in the USA will exceed the long-term trend.

Federal Reserve officials are increasingly valuing this possibility, which may influence policymakers' thoughts on economic potential. In the years leading up to the COVID-19 pandemic in 2019, the Fed had been steadily downgrading its estimates of the USA's sustainable long-term growth rate, partly due to productivity lag.

However, economic growth often exceeds the Fed's own estimates of potential, and this has continued over the past two years, even as inflation eased. Productivity growth has played a role, and if recent trends continue, the Fed may need to reconsider the direction of the economy and the potential inflation associated with any growth rate, which may lead to a higher estimate of the long-term 'neutral' interest rate that the USA market can bear.

Productivity issues are crucial for the Federal Reserve.

According to the minutes of the Fed's meeting from November 6 to 7, a reassessment is underway, with staff raising internal estimates of economic potential, and policymakers are debating whether recent trends will continue.

"I can't tell you how difficult it is to get productivity to exceed its long-term trend," said Fed Governor Cook last month.

Cook's economic research mainly focuses on innovation, stating that this shift (increasing productivity) has significant statistical and economic implications in recent years.

Like other Federal Reserve officials, Cook cited several possible reasons: more effective job matching, sustained high levels of business forms during the COVID-19 pandemic, and AI investments may continue to uphold this trend.

Chicago Fed President Goolsbee stated earlier this month, "We must begin to take seriously the idea that this situation is continuing," and clarify the policy implications.

"Some business people say... they find it difficult to hire, so they invested in machines. They use labor-saving technologies precisely because they can't find people," Goolsbee said. "I do believe there is some field evidence."

In economics, productivity is a kind of panacea; although it requires increased investment and innovation and is not entirely a free lunch, it allows workers to produce more with less time or fewer resources, thus enabling wages and profits to rise without triggering inflation.

Improving productivity has been one of the ways to control unit labor costs and remain consistent with the Federal Reserve's inflation targets, even as wage growth has consistently exceeded what policymakers regard as non-inflationary levels.

This is one of the reasons why the Federal Reserve is still willing to continue lowering interest rates while economic growth remains above trend and the unemployment rate is at a reasonable level.

The current question is whether it can continue and for how long.

Earlier this month, Federal Reserve Governor Kugler stated that recent strong productivity is "very important" for the economy and the central bank, but warned that upcoming changes in global tariffs and trade policies could pose risks.

"It is still too early to determine because the incoming government and Congress have not yet implemented any policies," Kugler said. "However, when specific details emerge, it will be important to study them because trade policies may affect productivity and prices."

Editor/ping