ORLANDO, Florida, Dec 11 (Reuters) - Federal Reserve

Chair Jerome Powell admitted on Wednesday that there is still no

"risk-free" path for the central bank as it seeks to bring down

stubbornly high inflation while also supporting an increasingly

creaky labor market. But he suggested the Fed might have a

"get-out-of-jail-free" card: higher productivity.

Speaking to reporters after the Fed cut its policy rate by

25 basis points and published its revised economic projections,

Powell indicated that productivity may square the circle of

solid growth, sticky inflation and a soft jobs market.

High productivity means workers are producing more output

per hour. This keeps a lid on unit labor costs and therefore

inflation, while also helping to drive stronger wage growth,

purchasing power, and overall economic activity.

It is a big factor behind Fed officials' rosier outlook for

2026 and expectation for only one more quarter-point rate cut

next year.

Policymakers raised their median 2026 GDP growth projection

to 2.3% from 1.8% in September, while lowering their outlook for

headline inflation to 2.4% from 2.6%. Powell said almost half of

the growth upgrade reflects a reacceleration of activity

following the government shutdown, but much of it is due to high

productivity too.

And that's not only because of artificial intelligence.

Powell said the U.S. economy's elevated productivity rate of

around 2% for the last several years predates the recent AI

boom. But the new technology is helping.

"There is no risk-free path for monetary policy," said

Jeffrey Roach, chief economist for LPL Financial, echoing

Powell, "but it seems the committee is banking on higher

productivity, implying stronger growth despite softer job

creation."

BETTING ON THE WRONG HORSE?

But there are potential problems with the productivity

story.

First, relying on it as a silver bullet is a gamble, both

because productivity is notoriously challenging to forecast - or

even to measure properly - and because it is too early to say

what the economic impact of AI will be.

As a recent Institute of International Finance report

warned, "if AI adoption remains concentrated among a handful of

hyperscalers and specialized firms, returns will likely plateau,

leaving overall growth vulnerable once the current investment

cycle peaks."

What's more, the flip side of AI's positive impact on

productivity could be massive job losses. This could create

"social and labor market implications that we don't have the

tools to deal with," Powell said.

Second, higher sustained productivity implies faster growth

and therefore a higher neutral rate of interest, or "r-star."

That's the neutral interest rate that neither stimulates nor

restricts activity when the economy is running at full

employment with stable inflation.

Powell said policy is now in a broadly neutral range, with

rates having been cut 175 basis points since September last

year. But if there is a productivity boom underway and potential

growth is higher, r-star and the fed funds rate should be higher

too.

In this scenario, current policy might actually be too

loose.

"All things equal yes, but all things aren't equal," Powell

said when asked on this matter on Wednesday. "There are many

things pushing in different directions on where the neutral rate

would be."

Estimates of r-star, a theoretical figure, are

understandably varied. Two closely watched models co-created by

New York Fed President John Williams put r-star at 1.37% or

0.84% at the end of June. Fed officials' median long-run implied

r-star projection is around 1%.

Productivity may offer the Fed some breathing room. Powell

indicated that the Fed will pause to assess the incoming data

before determining its next move. Rates futures markets believe

him and are not fully pricing in another rate cut until June.

"They are buying into the AI productivity story. That's the

only way you can interpret this," said David Kelly, chief global

strategist at JP Morgan Asset Management.

Of course, if that story does not play out, Powell and his

successor will have their work cut out for them in 2026.

(The opinions expressed here are those of the author, a

columnist for Reuters)

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