U.S. nonfarm productivity was reported up 1.2 percent at an annual rate in the fourth quarter of 2024, as output rose 2.3 percent and hours worked were up 1.0 percent. The 1.2 percent figure missed expectations for a gain of 1.8 percent.

Productivity increased 1.6 percent compared to the fourth quarter of 2023. Annual average productivity increased 2.3 percent from 2023 to 2024, pretty respectable.

Meanwhile, on the inflation front, unit labor costs rose at a 3.0 percent annualized rate in the fourth quarter after a revised 0.5 percent rise in the third quarter (previously reported up 0.8 percent). Expectations called for a 3.3 percent figure for the fourth quarter, so it was marginally better than expected, and certainly a relief that it was not worse.

Unit labor costs are up 2.7 percent over the last four quarters. The 3.0 percent increase in ULC for the latest quarter reflected a somewhat worrisome 4.2 percent rise in hourly compensation and a 1.2 percent increase in productivity.

The first reading on productivity for the fourth quarter is expected to show an annual gain of 1.8 percent compared with 2.2 percent in Q3. Unit labor costs are seen up 3.3 percent versus a small 0.8 percent in Q3.

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.