One leading explanation for the strong U.S. productivity growth is that labor markets in the United States tend to be more flexible and competitive, market characteristics that have allowed the United States to realize greater economic benefits from new technologies.  For example, taking full advantage of new information and communication technologies may require extensive reorganization of work practices, the reassignment and retraining of workers, and ultimately some reallocation of labor among firms and industries.  Regulations that raise the costs of hiring and firing workers and that reduce employers’ ability to change work assignments--like those that exist in a number of European countries--may make such changes more difficult to achieve. 

To make effective use of such a technology within a specific firm or industry, however, managers must supplement their purchases of new equipment with investments in firm- or industry-specific research and development, worker training, and organizational redesign--all examples of what economists call intangible capital.  Although investments in intangible capital are, for the most part, not counted as capital investment in the national income and product accounts, they appear to be quantitatively important.  One recent study estimated that, by the late 1990s, investments in intangible capital by U.S. businesses were as large as investments in traditional tangible capital such as buildings and machines (Corrado, Hulten, and Sichel, 2006).

Recognizing the importance of intangible capital has several interesting implications.  First, because investment in intangible capital is typically treated as a current expense rather than as an investment, aggregate saving and investment may be significantly understated in the U.S. official statistics.  Second, firms’ need to invest in intangible capital--and thus to divert resources from the production of market goods or services--helps to explain why measured output and productivity may decline or grow slowly during the period after firms adopt new technologies.  Finally, the concept of intangible capital may shed light on the puzzle of why productivity growth has remained strong despite the deceleration in IT investment.  Because investments in high-tech capital typically require complementary investments in intangible capital for productivity gains to be realized, the benefits of high-tech investment may become visible only after an extended period during which firms are making the necessary investments in intangibles.

On net, the recent experience does not appear to require a significant rethinking of long-term productivity trends.  Indeed, recent estimates by leading economists continue to peg the expected longer-term rate of productivity growth at roughly 2-1/2 percent per year.

The Fed, in the short run, tolerates the pressure rising energy prices exert on headline price measures, Mr. Bernanke said. "Our objective is to make sure it doesn't pass through into other wages and prices, in other words, that there are not second-round effects," he said.

"In the long run, what we would like to control is headline inflation," Mr. Bernanke said, "After all, that's what is determining the value of money, and it's what people need for their planning," along with being the force that "affects real wages and real incomes," he said.

"It is very difficult to eliminate the inflationary impact of the immediate effects of an increase in energy prices," he said. "Doing so would require forcing down wages and other prices quite dramatically to keep the overall price level from rising."

From Q&A session reported by the Wall Street Journal

And so, one of the benefits, I think, of a more open trading system, a more open economy, where we compete with and trade with countries around the world, despite the fact that it does create stress and sometimes changes and dislocations, is that competition forces productivity gains and has been, I think, a source of growth for us as well as for our trading partners.

It bears emphasizing that productivity growth seems likely to remain strong, supported by the diffusion of new technologies. Capital investment, and the creative energies of businesses and workers.  Thus, productive capacity should continue to expand over the next few years at a rate consistent with solid growth of real output.

Dynamic firms are the ones making the largest contributions to the nation's overall productivity growth, which is, at bottom, the fundamental source of rising standards of living. Accordingly, it is important that the economic statistical system do a good job of measuring not only output and employment growth but also intangibles, new cutting-edge products, and quality changes.

While energy is increasingly cited as a justification for price increases, many businesses—especially goods producers—can’t or won’t pass along higher costs. In part, that’s because global competition helps keep prices down and thus induces businesses to improve efficiency to maintain profits. The result is higher productivity, which helps to offset increased costs, including energy.

In the presence of a productivity surge, the Fed should not tighten but should instead let the economy enjoy the ride without fearing a rise in inflationary pressures.

Sound underlying economic fundamentals are supporting self-sustaining economic growth. Importantly, the fourth quarter aside, the underlying trends in productivity are quite solid.

We at the Chicago Fed think that after a strong rebound in the first quarter of 2006, real GDP growth will average somewhat above three percent over the next couple of years. We expect that the unemployment rate will change little from its current level and that inflation will remain contained. However, inflation currently is near the upper end of the range that I feel is consistent with price stability. As such, I believe monetary policy must be vigilant. We need to make sure that increases in resource utilization or prices of energy and other commodities do not add to inflationary pressures or increase inflation expectations.

Over the longer-term, if we want to keep improving our standard of living, we must make sure that productivity growth remains robust. Faster productivity growth generates faster GDP growth. This boosts our well-being. It also helps make the adjustments to the current account and fiscal deficits a much smoother process than if we were facing them from a base of lower GDP growth.

The expansion in global economic activity has become more broad-based. In the United States, underlying productivity growth remains strong and some of the structural changes underway in other mature, large economies offer the prospect of greater productivity growth in those countries, as well.

Productivity growth since 2000 has averaged 3.3 percent per year, which incidentally would double average incomes in less than 21 years. This is an astonishing performance over a time period with significantly lower rates of capital formation than in the late 1990s. Thus, recent productivity gains appear to owe somewhat more to the re-organization of business processes than to the application of additional capital. But as business investment continues to grow, productivity growth is likely to be driven more by capital formation. We should therefore pay special attention to current prospects for investment spending.

The robust productivity outlook for the United States relative to the rest of the world is consistent with an increase in the U.S. current account deficit, such as we experienced in the late 1990s. If this gap in potential growth were sustained, the United States would be able to sustain a larger external imbalance than we might have thought historically would be the case. But the present magnitude of the U.S. external imbalance seems difficult to reconcile with plausible estimates of future productivity and potential output growth.