American labour productivity demonstrated remarkable strength in the third quarter of 2024, with non-farm employee output per hour increasing at a 4.9% annualized rate, according to Bureau of Labor Statistics data. This performance marked the strongest productivity growth since 2023 and represented the second-strongest reading in two decades when excluding bounce-back quarters around recessions.

Declining Labour Costs Support Economic Efficiency

The productivity gains were accompanied by significant cost reductions, as unit labour costs declined for the second consecutive quarter. The data reveals a notable pattern of cost containment across recent quarters.

These developments create favourable conditions for continued inflation moderation while supporting economic growth and record stock market performance. The combination of rising efficiency and lower costs represents a positive economic dynamic that has been developing over three years.

AI Adoption Drives Business Transformation

Artificial intelligence adoption appears to be a significant factor behind the productivity surge. Census Bureau Business Trends and Outlook Survey data shows substantial growth in AI implementation across American businesses.

The survey methodology evolved during this period, with questions expanding from AI use in "production of goods and services" to "any business function," which may partially explain the dramatic increase in reported usage.

Productivity Impact Varies by Industry and Skill Level

Research studies demonstrate varying AI effectiveness across different sectors and worker skill levels. Marketing research by Harang Ju and Sinan Aral found human-AI teams achieved 73% higher productivity compared to all-human teams. In software development, developers using AI tools completed 26% more tasks than their counterparts without such assistance.

However, traditional industries show more modest gains. Taxi drivers using AI customer-finding tools experienced only 7% productivity improvements for low-skilled drivers, while high-performing drivers saw virtually no benefit. This suggests AI's effectiveness depends heavily on industry context and existing worker capabilities.

Monetary Policy Implications Remain Complex

The productivity gains present mixed signals for Federal Reserve policy considerations. While lower unit labour costs support disinflationary trends, higher productivity typically increases investment capital demand and potential GDP growth rates, potentially raising the neutral interest rate.

Federal Reserve rate adjustments have progressed significantly, with benchmark rates declining 75 basis points from the 4.25%-4.5% range in September to the current 3.5%-3.75% level. However, Federal Reserve Bank of New York data shows consumer inflation expectations rising to 3.42% for the next 12 months, up from 3.20% in November and moving further from the central bank's 2% target.

The productivity revolution's sustainability and broader economic implications remain uncertain, suggesting a cautious approach to monetary policy adjustments as additional data on productivity, inflation, and labour market conditions becomes available.

Raghuram Rajan, former RBI governor and distinguished economist at the Chicago Booth School of Business, has expressed concerns about the US Federal Reserve's monetary policy approach and the sustainability of the current artificial intelligence investment boom. Speaking to ET Now, Rajan outlined his views on global economic challenges, from persistent inflation to the competitive AI landscape.

Fed's Dovish Stance Raises Credibility Concerns

Rajan believes the Federal Reserve has adopted a distinctly dovish stance despite inflation remaining above target for nearly five years, raising questions about the central bank's long-term credibility. The economist suggests the Fed appears focused on supporting employment and cushioning the economy, possibly due to weaker labour market conditions than headline data indicates, along with political and social pressures related to affordability concerns.

"With growth estimates at or above potential, it is not as if policy is especially restrictive," Rajan noted. "The Fed seems to believe inflation will come down naturally, without keeping rates overly tight." He cautioned that prolonged tolerance of above-target inflation could eventually risk excess credit growth and renewed price pressures, even as the Fed attempts to provide economic insurance amid incomplete and delayed data.

US Economic Performance and Policy Challenges

The US economy continues to demonstrate strong performance, supported by massive artificial intelligence investments, buoyant asset prices, and stable housing markets. However, Rajan warned that tariffs and tighter immigration policies are exacerbating the affordability crisis faced by lower- and middle-income households.

"Tariffs raise prices. Cutting immigration also reduces labour supply, which can push inflation higher and slow potential growth," Rajan explained. He added that the return of manufacturing to the US is unlikely to generate large-scale employment, as new facilities are highly automated and require skilled technicians rather than mass labour.

AI Investment Boom: Real Demand, Uncertain Profits

Regarding artificial intelligence, Rajan acknowledged that demand is genuine and capacity is fully utilised, contrasting sharply with the unlit fibre infrastructure seen during the dotcom era. "There are no idle GPUs today; demand is scaling rapidly, especially from consumers," he observed.

However, the economist questioned whether current investments will translate into sustainable profits. While companies such as OpenAI, Google, and Meta are racing for market dominance, Rajan noted the market remains highly competitive with no clear monopoly emerging.

"The risk is not unused capacity but unprofitable capacity," he said, pointing to recent market reactions following weaker-than-expected results from companies like Oracle, which have made substantial bets on AI infrastructure.

China's Structural Economic Challenges

Rajan highlighted deeper structural issues facing China's economy, despite stabilising growth and strong performance in select technology stocks. He warned that overproduction, a struggling real estate sector, and an outdated growth model are forcing China to export excess capacity, triggering global trade tensions.

"China has doubled down on high-tech manufacturing without fixing its domestic demand problem," Rajan said, adding that many countries—including India and Europe—may respond with trade barriers.

Despite these challenges, Rajan acknowledged China's technological strengths and innovation capabilities even under restrictions. "Chinese firms are showing remarkable engineering sophistication. India should take this as a lesson—invest in universities, R&D and innovation, because this is an arms race we cannot afford to sit out," he advised.

Global Economic Outlook

Rajan characterised the global economic outlook as one of resilience coupled with rising medium-term risks. These risks include inflation persistence, potential credit excesses, geopolitical uncertainty, and increasingly fragmented trade relationships. While AI-led investment may sustain growth momentum, he emphasised that policymakers and investors should remain cautious about assuming smooth, profitable outcomes in the evolving economic landscape.