Fed officials are assuming there will be a rebound in productivity through innovation or investment in labor-saving technology like robotics, and that this will boost economic growth to around 2.5 percent next year. They also don't expect the jobless rate to fall much further through the end of this year.
But if productivity remains weak it could push the inflation rate higher and lead to a more aggressive policy tightening in the months and years to come. "Overall productivity has been disappointing," Boston Fed President Eric Rosengren told Reuters in a recent interview.
Manufacturing, where productivity fell by 1 percent in the first quarter compared with 3.1 percent economy-wide, should be at the forefront of the expected investment-driven bounce. But in a closely-watched proxy for investment, shipments from American factories of civilian capital goods other than airplanes rose only 0.6 percent in June from a year earlier, suggesting businesses are still shy about spending on anything beyond hiring.
While many industrial giants like Caterpillar have been squeezed by the strong dollar and weak overseas markets, triggering job cuts, smaller U.S. firms are in better shape. With less overseas exposure and accounting for 60 percent of job gains since the recession, they are planning to spend and hire more, according to a June survey by the National Federation of Independent Business.
For example, Gray Construction CEO Stephen Gray hired 67 people over the past six months to bring the workforce of his Lexington, Kentucky-based company up to 375. But he said wage increases were reserved only for the highly skilled workers, who made up about a third of new hires.
The company designs, engineers and manages building of factories for the likes of Toyota Motor Corp and Caterpillar, and Gray sees a "green light" for manufacturing until at least 2018 thanks to resilient U.S. consumption and, despite recent weakness, productivity that still tops that of European rivals.
But that doesn't mean it is spending heavily on new equipment.
"When we roll the dice it's on people," Gray said. "We're not buying robotics, we're not buying big software systems."
Wage growth tepid
After some tentative gains in recent months, U.S. wages were steady in June, with the average inflation-adjusted pay of manufacturing production workers, at $8.49 an hour, the same as it was in 2007, and little above the $7.25 an hour federal minimum wage.
A measure of employment costs, which also includes health and pension insurance, also stalled in the second quarter, though the weakness was not expected to last, according to economists and policymakers.
Tepid wage growth helps explain the productivity slump, says Mark Zandi, chief economist at Moody's Analytics. "It's been cheaper for companies to expand by hiring people rather than investing," he said. But once wages start rising, investment and productivity should pick up, he added.