It would be a mistake for the Federal Reserve to tolerate elevated inflation in pursuit of higher productivity growth, St. Louis Fed President Alberto Musalem said Thursday.
In prepared remarks at the Center for Public Policy Debate in Brazil, Musalem said that while there's a good chance that artificial intelligence will deliver efficiencies that will help the U.S. economy in the future, the evidence currently available has not signaled significant enough gains to justify easier monetary policy conditions.
"Setting monetary policy easier than conditions would otherwise warrant in pursuit of higher growth would be a mistake," Musalem said. "It is crucial that monetary policy put a meaningful restraint on underlying inflation, rather than tolerating somewhat higher inflation today to pursue productivity growth tomorrow."
Nonfarm business-sector labor productivity grew by 1.4% in the second quarter after rising by an upwardly revised 0.8% during the first quarter, according to data released Thursday by the Bureau of Labor Statistics. That's a bit slower than some readings in recent years, though still a solid underlying trend.
Robust productivity growth can help lift living standards and economic output without adding inflationary pressures. Many AI optimists, which Musalem self-identifies as, expect the surge in AI investments to sustainably raise productivity growth in the coming years.
It could be argued that lower interest rates, for example, could lead to more business investment and coax faster productivity growth -- which could eventually lower production costs and, by extension, inflation. So accepting a little more inflation now might pay for itself later.
But Musalem contends that this reasoning takes the central bank's credibility in delivering price stability for granted. "The bargain only works because households, firms and investors keep expecting inflation to return to target," he said. "A central bank seen to tolerate above-target inflation on the promise of a future productivity windfall can put that anchor at risk."
Credibility, once lost, is difficult to reestablish, Musalem added.
Musalem's remarks come as the Fed has recently gotten more involved in monitoring productivity under Chairman Kevin Warsh. The central bank's policymaking arm, the Federal Open Market Committee, released statements in June and July that not only included a reference to productivity growth, but also characterized it as "strong."
Additionally, one of the five task forces Warsh has formed at the Fed is focused on productivity and jobs, with the goal of assessing the economic impact of new general-purpose technologies, including AI. Warsh reiterated during the July FOMC press conference that he believes productivity is one of the "big questions" that central bank officials will need to grapple with when setting monetary policy.
Over the past six years, U.S. labor productivity has grown at an annualized rate of roughly 2.1% through the second quarter, outperforming the 1.5% annual average from the end of 2007 through 2019, according to BLS data.
While that's an improvement, it's hardly the level of productivity growth that prompted the Fed to note strong gains experienced during the mid-2000s, when Alan Greenspan chaired the central bank. From 2002 to 2005, labor productivity growth averaged 3.3% annually.
The best thing that a central bank can do is ensure that there are stable prices, Musalem said. That, he added, gives businesses a solid foundation to plan the investment and innovation that fuel economic and productivity growth.
"The job of fostering productivity growth is better suited to fiscal and regulatory policy," Musalem added.
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