Nonfarm labor productivity, as measured by output per hour, topped expectations as it increased 3.2 percent at an annualized rate in the preliminary report for the fourth quarter 2023, above Econoday's consensus of 2.3 percent. The third quarter estimate was revised down to 4.9 percent from 5.2 percent.

Output expanded 3.7 percent after 5.8 percent in the third quarter, and hours worked increased 0.4 percent after 0.9 percent.

Meanwhile, unit labor costs rose less than anticipated, with a 0.5 percent gain following a 1.1 percent drop in the third quarter.

For 2023 as a whole, nonfarm productivity recovered 1.2 percent after falling 1.9 percent in 2022, as output growth accelerated to 2.6 percent from 2.1 percent, while hours worked rose 1.3 percent in 2023 after a 4.0 percent advance in 2022. Unit labor costs were up 2.9 percent last year, a slower growth pace than 5.6 percent in 2022. Hourly compensation increased 4.2 percent after 3.7 percent. Adjusted for inflation, it edged up 0.1 percent in 2023 after falling 4.1 percent in 2022.

Nonfarm productivity is expected to slow to a 2.3 percent annualized rate in the fourth quarter versus 5.2 percent growth in the third quarter. Unit labor costs, which fell 1.2 percent in the third quarter, are expected to rise to a 2.1 percent rate in the fourth quarter.

Productivity measures the growth of labor efficiency in producing the economy's goods and services. Unit labor costs reflect the labor costs of producing each unit of output. Both are followed as indicators of future inflationary trends.

Productivity growth is critical because it allows for higher wages and faster economic growth without inflationary consequences. In periods of robust economic growth, productivity ensures that inflation will remain well behaved despite tight labor markets. Productivity growth is also a key factor in helping to increase the overall wealth of an economy since real wage gains can be made when workers are more productive per hour.

Productivity and labor cost trends have varied over the decades. In the late 1990s, some economists asserted that dramatic productivity advances (based on new technologies) were then allowing the economy to sustain a much faster pace of growth than previously thought possible. Initially, some Fed officials expressed skepticism but later decided that productivity gains had helped boost economic growth and potential GDP growth during the 1990s. That is, the economy could grow faster than previously believed without igniting inflation.

Determining the source of productivity gains has become trickier over the last decade as new technology continues to be incorporated into production - not just in the U.S. but overseas also. Similarly, retraining U.S. workers has been sporadic. Not just low skill jobs are outsourced but now many highly skilled jobs such as programming and accounting are as well. Nonetheless, highly skilled professional jobs have been increasingly difficult to fill during times of high demand. Despite the cross currents in labor market trends, long-term productivity gains are important for maintaining growth in labor income and keeping inflation low.

But in the short-term, output and hours worked can shift sharply just due to cyclical swings in the economy. During the onset of recession, output typically falls before hours worked. This can result in a temporary drop in productivity and a spike in unit labor costs. So, while long-term productivity determines the"speed limit" for long-term growth, one should not be misled by short-term cyclical gyrations in productivity numbers as reflecting the true, underlying trend.