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Robert J. Gordon, Northwestern University and NBER, NABE 48 th Annual Meeting, NBER Session, Copley Place Marriott, Boston, September 11, 2006 The U. S. Productivity Growth “Explosion”: Dimensions, Causes, Consequences, Aftermath

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Brief Survey of NBER Research on Macro Productivity Issues Research Papers on my web site, google “Robert J. Gordon” Research Papers on my web site, google “Robert J. Gordon” Topic #1 on quarterly productivity behavior, today’s unpublished update of BPEA 2003 Topic #1 on quarterly productivity behavior, today’s unpublished update of BPEA 2003 Topic #2 on inflation, unpublished update of BPEA 2005 with added dire implications for Bernanke Topic #2 on inflation, unpublished update of BPEA 2005 with added dire implications for Bernanke Topic #3 on Europe, new paper on web site (unfortunately no time to talk about this) Topic #3 on Europe, new paper on web site (unfortunately no time to talk about this)

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Broad-ranging Interpretation of U. S Productivity “Explosion” #1. Causes, Were they Temporary, Dimensions of Future Slowdown #1. Causes, Were they Temporary, Dimensions of Future Slowdown #2. Effects of Productivity Growth on Core Inflation and the Fed’s Dilemma #2. Effects of Productivity Growth on Core Inflation and the Fed’s Dilemma For this NABE Audience the quarterly analysis of U. S. data will be emphasized For this NABE Audience the quarterly analysis of U. S. data will be emphasized Lots of charts, new analysis here done since early August BEA and BLS data releases Lots of charts, new analysis here done since early August BEA and BLS data releases

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Topic #1: Behavior of Productivity Growth in Quarterly Data Important to understand the dynamics Important to understand the dynamics They have nothing to do with the NBER business cycle chronology They have nothing to do with the NBER business cycle chronology The behavior of productivity is driven by the lag of hours behind output The behavior of productivity is driven by the lag of hours behind output This was a topic of the early 1960s, Okun’s Law and Walter Oi on labor as a “quasi-fixed factor” This was a topic of the early 1960s, Okun’s Law and Walter Oi on labor as a “quasi-fixed factor”

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8-quarter Change in NFPB Output and Hours,

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Key Implications of Lag in Hours Behind Output Productivity Growth is not Synchronized with the utilization of resources Productivity Growth is not Synchronized with the utilization of resources Because hours lags, productivity leads Because hours lags, productivity leads Productivity Growth is fastest at the beginning of the recovery Productivity Growth is fastest at the beginning of the recovery The “early recovery productivity bubble” The “early recovery productivity bubble”

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Notice the “Early Recovery Bubble”, 8-qtr changes

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Trend Methodology Two Leading Methods of Detrending Two Leading Methods of Detrending Hodrick-Prescott Filter Hodrick-Prescott Filter –Normal Paramater of 1600 bends too much and allows too much of the “cycle” to get into the trend. –Everything here uses HP 6400 Kalman Filter. Allows correcting for changes in the business cycle Kalman Filter. Allows correcting for changes in the business cycle

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Alternative U. S. NFPB Productivity Trends in Quarterly Data,

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8-quarter Actual LP vs. the Average Trend

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The Early Recovery Bubble, How Much “Payback” is Left? 2001:3-2004:2, 11 quarter AAGR 2001:3-2004:2, 11 quarter AAGR –Actual 3.87 –Trend 2.92 –Difference 0.95, or cumulatively :2-2006:2, 8 quarter average 2004:2-2006:2, 8 quarter average –Actual 2.00 –Trend 2.68 –Difference -0.68, or cumulatively -1.37

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What Implications for 2006:Q2-2008:Q2? Start by Assuming that the trend slows a bit further from 2.68 to 2.50 Start by Assuming that the trend slows a bit further from 2.68 to 2.50 Remaining “payback” of 2.62 (01-04) minus 1.37 (04-06) equals 1.25 Remaining “payback” of 2.62 (01-04) minus 1.37 (04-06) equals 1.25 Distributing that over next two years implies actual AAGR = 1.88 Distributing that over next two years implies actual AAGR = 1.88 Anything below that would imply the trend is lower than 2.50 Anything below that would imply the trend is lower than 2.50

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The “Output Identity” Organizational Tool for Trends, Cycles, and Residuals In its Simplest Form Makes Output (Q) Equal to the product of: In its Simplest Form Makes Output (Q) Equal to the product of: –Productivity (Q/A) –Hours per Employee (A/E) –Employment Rate (E/L), that’s just (1 – U/L) –Labor-force Participation Rate (L/N) –Working-age Population (N) Hiding Inside the Output Identity are Numerous Useful Trend and Cyclical Relationships, including OKUN’s Law. Hiding Inside the Output Identity are Numerous Useful Trend and Cyclical Relationships, including OKUN’s Law.

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Five-term Output Identity Cannot be Used for Empirical Analysis Productivity data for the NFPB sector Expand the identity to identify NFPB variables and links to total economy: Mix effect – ratio of output per employee: total/NFPB sector Employment ratio of payroll to household

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The Novelty here is to Display the Seven Components We’ll look through each of them, plotting actuals (8-qtr MAs) vs. trends We’ll look through each of them, plotting actuals (8-qtr MAs) vs. trends We’ll pay special attention to what has happened to each over the past six years We’ll pay special attention to what has happened to each over the past six years Then we’ll multiply them together to see what has happened to potential real GDP growth Then we’ll multiply them together to see what has happened to potential real GDP growth

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Actual vs. Trend Growth for Hours per Employee

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Actual vs. Trend Growth for Labor Force Participation

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Actual vs. Trend Growth for the Employment rate

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Actual vs. Trend Growth for Wkg-Age Population

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Actual vs. Trend Growth for the “Mix Effect”

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Actual vs. Trend Growth for Payroll vs. Household Employment

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Two Measures of Trend Potential GDP Growth

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Potential GDP vs. Productivity: the Trend Story in Table 2 Potential GDP growth (Δq*) ranged from: Potential GDP growth (Δq*) ranged from: –4.03 in to 2.69 in –Differences accounted for by Productivity (peak ) Productivity (peak ) Population growth (peak ) Population growth (peak ) LFPR (peak ) LFPR (peak ) –Offset by hours/employee (peak ) Currently growth rate is 2.9 percent by one measure and 3.0 percent by the other Currently growth rate is 2.9 percent by one measure and 3.0 percent by the other

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Log Ratio of Actual to Potential Real GDP

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Okun’s Law Updated: What Happens with Changes in Ratio of Actual to Potential? When the ratio of actual to potential real GDP rises by 1 percent, the following happens (after allowing for lags) When the ratio of actual to potential real GDP rises by 1 percent, the following happens (after allowing for lags) The unemployment rate falls by 0.50 The unemployment rate falls by 0.50 Productivity growth rises by 0.16 Productivity growth rises by 0.16 Hours per employee rise by 0.10 Hours per employee rise by 0.10 LFPR rises by 0.10 LFPR rises by 0.10 Residual distributed across other factors Residual distributed across other factors

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Why Did Productivity Growth Accelerate Further, ? Hypotheses in 2003 BPEA paper Hypotheses in 2003 BPEA paper –Savage corporate cost cutting (profits hardly fell in but fell by half in ) –Intangible capital Implications of Industry Decomposition Implications of Industry Decomposition –Jorgenson and Stiroh: IT no role after 2000 –Sichel’s new numbers show IT no more important in than in pre-1995 Added Element from Jorgenson-Stiroh, forthcoming slowdown in “labor quality” Added Element from Jorgenson-Stiroh, forthcoming slowdown in “labor quality”

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Implications for Interpretation What does it mean that no special role of IT use in or acceleration? What does it mean that no special role of IT use in or acceleration? –Stiroh’s interpretation: a broad cross-the-board upsurge in TFP growth unrelated to IT investment –My 2003 BPEA interpretation, unusual pressure for corporate cost-cutting due to late 1990s bubble, overshooting, accounting scandals Stiroh: It’s permanent, but we don’t know why Stiroh: It’s permanent, but we don’t know why Me: Big but temporary adjustment in corporate organization and cost structure. Trend is headed from 2.6 now to Me: Big but temporary adjustment in corporate organization and cost structure. Trend is headed from 2.6 now to Potential GDP headed from 2.9 to 2.6 Potential GDP headed from 2.9 to 2.6

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Effects of Productivity Growth on Inflation Details of the inflation model and its treatment of productivity are in BPEA 2005, no. 2 (and on my web site) Details of the inflation model and its treatment of productivity are in BPEA 2005, no. 2 (and on my web site) “Where Did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income” “Where Did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income” The 2005 BPEA paper was co- authored with Ian Dew-Becker The 2005 BPEA paper was co- authored with Ian Dew-Becker

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“Triangle” Model of Inflation Developed in late 1970s, intact since 1980 Developed in late 1970s, intact since 1980 Two sides of the triangle are demand and supply Two sides of the triangle are demand and supply The base of the triangle is inertia The base of the triangle is inertia

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How it Works: Explains Headline PCE Deflator Demand enters through the unemployment gap (TV-NAIRU) Demand enters through the unemployment gap (TV-NAIRU) Supply shocks (changes relative to zero) Supply shocks (changes relative to zero) –Food-energy effect –Relative price of imports –Change in trend productivity growth Inertia: allow 24 quarters to enter Inertia: allow 24 quarters to enter

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How the Model has Changed since 1980 Before 1995, assumed the NAIRU was fixed at 6.0 percent Before 1995, assumed the NAIRU was fixed at 6.0 percent Actuals fell below predictions in Actuals fell below predictions in Adopted Stock-Watson technique of estimating a NAIRU that varied over time Adopted Stock-Watson technique of estimating a NAIRU that varied over time The technique simultaneously estimates the inflation equation coefficients and the TV- NAIRU The technique simultaneously estimates the inflation equation coefficients and the TV- NAIRU

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The TV-NAIRU with and without Supply Shocks

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The Model Also Produces Post-Sample Dynamic Simulations Post-Sample Dynamic Simulations Have Coefficients Changed? Have Coefficients Changed? –Instead of , estimate only for –Lagged inertia effect for then generated endogenously –This is the key technique to reveal changes in coefficients, or “drift”

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Here are the Three Supply Shocks Food and Energy Effect Food and Energy Effect –This is simply headline PCE inflation minus core PCE inflation Change in relative price of imports Change in relative price of imports Change in productivity trend growth, from the research summarized earlier Change in productivity trend growth, from the research summarized earlier A Consistent Theme: A Consistent Theme: Greenspan’s Gifts! Greenspan’s Gifts!

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Food-Energy Effect,

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Change in Relative Import Price,

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Change in the Productivity Growth Trend,

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The Effect of Future Changes in Prod’y Growth

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The Dilemma that Bernanke has Inherited

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With a “Neutral” Set of SS, What is Need to Maintain 2.0% “Comfort Zone”?

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Conclusion about Bernanke’s Dilemma Due to long inertia lags, nobody has noticed Due to long inertia lags, nobody has noticed –Oil prices really do get into core inflation –So do rising relative import prices if/when dollar falls –So does the productivity turnaround Bernanke is now stuck with ~3.0 not 2.0 core inflation Bernanke is now stuck with ~3.0 not 2.0 core inflation

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There are only Two Choices The first choice is to create a recession with several years of unemployment above 6 percent The first choice is to create a recession with several years of unemployment above 6 percent The second choice is to abandon any pretense of a 2.0 (or even 2.5) core inflation target The second choice is to abandon any pretense of a 2.0 (or even 2.5) core inflation target NYT Jackson Hole coverage suggested the second option has already been chosen but they won’t say so (of course) NYT Jackson Hole coverage suggested the second option has already been chosen but they won’t say so (of course)

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No Time for Topic #3, Europe’s Turnaround I’ll just leave you with two enticing graphs I’ll just leave you with two enticing graphs The details are on my web site, look for the paper about “Tigers and Tortoises” (also co- authored with Ian Dew-Becker). The details are on my web site, look for the paper about “Tigers and Tortoises” (also co- authored with Ian Dew-Becker). Post-1995 reversal in EU-US productivity growth Post-1995 reversal in EU-US productivity growth Post-1995 reversal in EU-US hours growth Post-1995 reversal in EU-US hours growth

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Here’s Productivity Growth,

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The Stunning Turnaround in Hours per Capita

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