US economy’s potential growth rate can be split into growth in the size of the labor force and growth in labor productivity. Since 2019, economywide labor productivity rose about 1.6% per year, well above its pre-pandemic average of 1.2%. At the same time, elevated immigration in 2022-2024 boosted annual labor force growth to about 0.8% on average since 2019 (vs. 0.6% before the pandemic). As a result, the economy’s potential growth rate rose from about 1.8% before the pandemic to around 2.4% in the years since. Going forward we expect the contribution of labor force growth to potential GDP growth to average 0.3pp over the next few years (vs. 0.8pp since 2019 and 0.6pp in 2007-2019). Nonfarm business labor productivity grew 2% on average in the last five years, compared to about 1.5% pre-pandemic. Most of this increase in non farm labor productivity was on account of AI capex. Looking ahead, we expect productivity growth to pick up further as increases in AI adoption and investment boost capital per worker and improve efficiency. Taken together, we expect economywide productivity growth to average about 1.7% through 2029 and 1.9% in the early 2030s. Together with our forecasts for labor force growth, these estimates suggest that potential GDP growth will likely average about 2.1% in 2025-2029 before accelerating to 2.3% in the early 2030s as AI boosts growth further. In our view, a productivity-driven increase in real interest rates is the most powerful driver a currency can have. Over the last 50 years there has been a broad correlation between long swings in USD strength and productivity growth. To conclude, if the current AI capex cycle is able to add productivity gains to US economy, we might see a large productivity surge in US leading to higher potential output, higher real rates and higher DXY. And if the AI story goes bust in next 2 quarters, one can see far lower potential output, lower real rates and lower DXY.
