Productivity Growth Jude Wanniski February 4, 2005

From: Jude Wanniski  <jwanniski@polyconomics.com        
To:      Ben.S.Bernanke@ * * * * *.GOV                                               
Subject: Fwd: Bernanke - Productivity Growth
X-Attachments: c:\program files\qualcomm\eudora\attach\Jude - Productivity.xls;

5:43 pm, 1/19/2005

Ben... I did not have time to read your productivity speech, swallowed up by the Condi Rice hearings (she is dreadful), so I asked Paul Hoffmeister to give a read and write me a note. Here it is.... I'll try to find time when the smoke clears to read it for myself, but his memo to me sounds like he has got it right.  What he comes down to saying is that since we went off gold in 1971, productivity declined to a point where it then, in recent years, has come back, and our standard of living is really only back to where it was 35 years ago.   Jude

From: "Paul Hoffmeister" <phoffmeister@polyconomics.com>
To: "Jude Wanniski" <jwanniski@polyconomics.com>
Subject: Bernanke - Productivity Growth
Date: Wed, 19 Jan 2005 14:08:41 -0500

Jude,

Bernanke's speech seems to be a complete demand-side examination of productivity growth.  In his conclusion, he attempts to explain the effect of productivity growth on inflation.  He's got the cart in front of the horse, I think.  No where in the speech does he try to explain productivity growth based on changes in the price level.

I attached a rough graph I just made to show the 1yr. moving average in productivity growth compared to gold's implied inflation rate.  I think it essentially illustrates that stable monetary policy results in more superior and more consistent productivity growth.

For your quick reference, here are Bernanke's conclusions, toward the end of the speech:

"What are the implications of these observations for current monetary policy? Certainly, monetary policy makers should pay close attention to developments on the productivity front, as the effects of changing productivity trends permeate the economy. However, as we have seen, the appropriate policy response to any perceived change in the trend rate of productivity growth will depend to a significant degree on the response of private-sector spending. For example, if productivity growth appears poised to decelerate, but (for whatever reason) aggregate private spending does not slow materially in response, then inflation risks would rise, but employment would not be adversely affected. The appropriate response in this case would be a tightening of monetary policy (or a more rapid removal of accommodation). On the other hand, if slower productivity growth were accompanied by a sufficiently large slowdown in aggregate demand and
economic activity, then easier monetary policy (or a slower removal of policy accommodation) might be called for.

My best guess--and it is only a guess--is that future responses of consumption and investment spending to changes in the pace of productivity growth are likely to be less powerful than those of the late 1990s, if for no other reason than that we may have learned to be more careful in our enthusiasms. If so, then the principal effect of an unexpected slowdown in
productivity growth during the next few years would likely be higher inflation, with the short-term impact on the growth of output and employment likely to be relatively minor. In this scenario, the appropriate monetary policy response would be toward less accommodation. By similar reasoning, if productivity growth were to accelerate in the next few years, then easing
inflation pressures and slowing employment growth would likely allow for less-restrictive policies. As I have emphasized, however, these conclusions depend on other developments in the economy, most importantly on how strongly aggregate spending responds to any perceived change in secular productivity growth."

Paul