“Foundations of the Goldilocks Economy: Supply Shocks and the Time-Varying Nairu”
“The High Pressure U.S. Labor Market of the 1990s”
“Computers and Aggregate Economic Growth”
“Economic Statistics, the New Economy, and the Productivity Slowdown”
The Emerging Digital Economy
The rapid economic growth of the past few years has surprised even the most optimistic forecasters, and it has made a significant difference to Americans’ sense of themselves. The volume of goods and services the economy produces, the Gross Domestic Product (GDP), has grown at an annual rate of nearly 4 percent, discounted for inflation, since 1996. Few economists projected rates of growth as high as 3 percent a year. Only a few years ago, experts said that labor productivity, the output of the economy per hour of work and the source of a nation’s rising standard of living, was barely growing. But it has grown by more than 2 percent a year on average since then, and grew by an annual rate of 3 percent in the nine months ended in June.
The fall in the rate of unemployment has had the greatest social effect. It now stands at 4.3 percent, lower than at any other time since the 1960s. A reduction in unemployment does not simply mean that a higher proportion of people have jobs. It also means that the demand for workers in general is strong, making most jobs more secure and forcing wages to rise as well. During the past three years, wages have done just that, not merely rising for better-off workers, as they did for the previous two decades, but rising by about 8 percent after inflation on average for low-income workers as well. As a result, income inequality, which widened dramatically in the 1980s and early 1990s, is at last narrowing.
Meantime, inflation has, until recently, continued to subside, defying every economic forecast that I have seen. Consumer prices rose 2 percent during the last year. This surprisingly low rate of inflation enabled the nation’s central bank, the Federal Reserve, to lower interest rates rather than raise them as had been expected with such rapid rates of growth. Long-term mortgage rates fell to around 7 percent in mid-1998, for example, making the monthly cost of financing a home purchase lower compared to average family income than it had been in nearly twenty years. Low mortgage rates have made home equity loans to finance other kinds of consumption highly attractive. Low inflation and interest rates have also been powerful stimulants for the stock market, and high stock prices in turn have been a foundation for unusually strong consumer spending that has literally outpaced increases in income in recent months.
To a growing number of observers, this exuberant performance suggests a deep change in America’s prospects. A common explanation is that computerized technological advances have at last turned the economy around. The slow rates of growth that persisted since the early 1970s and led to historically torpid growth in wages for most Americans have ended, some now say, as a new information age at last takes hold. There is a great deal of doubt among economists about this. Many argue that the economy reached a high rate of growth in the last three years that cannot be maintained, in part because it has been supported by soaring stock prices and a growing mountain of debt. Corporate borrowing rose by 10 percent last year, for example, faster than it has since the 1980s, and consumers keep borrowing more on their credit cards and against the value of their homes.
But whatever the causes of the current prosperity, much of America is clearly confident again after two decades in which its citizens continually expressed fears that institutions of all kinds—religious, economic, and political—had lost their sense of direction. The slow economic growth that began in the early 1970s accounted for the social and political confusion to a greater degree than was generally recognized. There was a widespread impression that government—and especially social programs—no longer worked as federal revenues failed to rise as rapidly as they once did. Had the economy grown by merely 1 percent a year more between 1973 and the mid-1990s, for example, federal revenues would have been more than $400 billion higher per year in the mid-1990s.
Because wages stagnated or fell, consumers felt under pressure to save less in order to keep up their standards of living. Jobs were not sufficiently available to relieve poverty in the inner cities, and this contributed to rising crime rates. White male workers in particular had falling average wages and they lost jobs at a high rate, raising tensions in the American family as wives went to work in record numbers and often became the principal breadwinners. Meantime, the gap in wages between African-American and white men remained wide, after narrowing between 1965 and 1975.
The more rapid growth of the past few years has begun to reverse these conditions. The sudden bulging surplus in the federal budget is already tangible evidence of the benefits of rapid economic growth. Tax receipts rose rapidly along with incomes and were further inflated by the increased tax collections on capital gains earned in the financial markets. If such rates of growth continue, even the future financial deficits of Social Security and Medicare will be dramatically reduced.
As a result, surveys find consumer confidence is at an all-time high. The nation shows signs of being more generous, as evidenced by the waning demand for tax cuts and the willingness of state and city governments to spend more public funds on education and transportation. Despite passing an $800 billion tax reduction that the President promises to veto, Republicans in the House are restoring spending cuts for housing, urban development, and other social programs.1 These new spending initiatives are also evidence, I think, that Amer-ica’s much-discussed divisiveness, frequently attributed to the lack of shared ideological and moral principles, has subsided noticeably (as partly suggested by the lament of conservatives that the public supported Clinton during the impeachment hearings). Similarly, it has been thought that inner-city problems were the inevitable result of an intransigent underclass that is alienated from society. But many of the poor in the inner cities are also working again, and crime rates are falling in many of these neighborhoods.2
This is exactly what economic expansions are expected to do. But the expansions of the US economy of the 1970s and 1980s were not nearly as strong as those of the past. And until only recently, the 1990s expansion was the weakest of all. In fact, the current median family income (less than that of 50 percent of the population and more than that of the other 50 percent) of about $46,000 is still only slightly higher than it was in 1989, discounted for inflation; and the median family income of 1989 was itself only a few thousand dollars higher than it was in the early 1970s. The wages of the average worker are only now just reaching their 1989 level, and are still about 10 percent below the level reached in 1973. Lost in the current enthusiasm is what a long way there still is to go.3
Moreover, the growth of real GDP and productivity since 1996 has been no faster than it was during similarly strong but short-lived periods in the 1970s and 1980s that soon exhausted themselves. For example, beginning in Reagan’s first term, between 1982 and 1986, the fastest growing years of the 1980s, real GDP (discounted for inflation) grew by 4.5 percent a year compared to 4 percent a year recently; but the rate of growth of GDP then quickly subsided to only about half as fast over the next ten years. In these same fast-growing years of the early 1980s, labor productivity increased by a rate of 2.4 percent a year (compared to about 2.1 percent a year recently), but in the subsequent ten years it grew at less than half that on average. If the performance of the past few years were truly a turning point, the rates of growth should have probably exceeded historical rates. (They have not been close to the best rates of growth of similar three- and four-year periods in the 1950s and 1960s.)
Admittedly, more rapid growth has come late in the 1990s business cycle, and this has impressed economists. The more rapid growth in the 1980s cited above followed a steep recession; at such a point, growth is usually strongest. But the 1990s cycle has reversed the normal sequence of events. The rate of growth was unusually weak early in the cycle, after the recession of the early 1990s. For example, the rate of unemployment was actually higher in 1993, when the recovery was two years old, than it was at the bottom of the recession in 1991 (and almost as high well into 1994). This was unprecedented for the first two years of a new business cycle. Pro-ductivity was almost stagnant in these years. After an initial burst in 1992, it grew by 0.1 percent in 1993, 0.5 percent in 1995, and 0.6 percent in 1996.
Thus, the late bloom of the economy, beginning in 1996, followed an extremely sluggish period of growth in which demand for consumer and perhaps even capital goods could not be fulfilled. It is possible this pent-up demand has given impetus to current high levels of consumer spending. Even Alan Greenspan, the Federal Reserve chairman, conceded in a speech in May (covering all sides of the issues as usual) that the re-cent economic performance may largely be a catch-up after the unusually slow growth of the first half of the decade.
Also, the data have been inflated significantly since 1995 by revisions which have reduced consumer prices and therefore raised business output, adding approximately 0.4 percent to reported productivity growth each year. This large adjustment will soon be made to earlier data, making the current performance less strong by comparison. Many gushing press accounts leave out this fact.
This summer, the good economic news has been tested. On the one hand, economic growth slowed to an annual rate of only 2.3 percent and productivity growth to only 1.3 percent in the three months ended in June. On the other hand, there have been increasing concerns that the rate of inflation may at last be rising. In particular, the value of the dollar has fallen against the yen and the European Union’s euro, which is helping to drive up import prices. In response to such inflationary threats, the Federal Reserve raised its key federal funds rate by a quarter of a percent in June and another quarter of a percent late this August. Long-term mortgage rates have risen to more than 8 percent, and demand for goods and services may well now be slowing.
Nevertheless, the rate of inflation has remained subdued, and a three-month slowdown in productivity growth obviously cannot be taken as a sign of a trend. Something more than simply a temporary cyclical improvement may be underway. Also, the low rate of unemployment has reminded us once again of the benefits of tight labor markets, which the nation has not experienced for twenty-five years. The rising wages for lower-income workers, for example, raise new questions about a long-held tenet among most mainstream economists. The experts have generally attributed widening income inequality to technological advances that require more sophisticated, better-educated workers. But as labor markets have tightened since 1996, even low-skilled workers have been in demand. Technological change no doubt remains an influence over the job markets, but it is increasingly clear that a low unemployment rate has remarkable curative powers.
For example, see Mitchel Benson and Jacob M. Schlesinger, "States' Tax-cutting Binge is on the Wane," Wall Street Journal, May 13, 1999, p. A2; and Tim Weiner, "House Speaker to Shift Tacks in Spending Bill," The New York Times, June 5, 1999, p. A11.↩
Richard B. Freeman and William M. Rodgers, "Area Economic Conditions and the Labor Market Outcomes of Young Men in the 1990s Expansion," NBER Working Paper No. 7093, April, 1999.↩
Economic Report of the President, Council of Economic Advisers, 1999.↩
For example, see Mitchel Benson and Jacob M. Schlesinger, “States’ Tax-cutting Binge is on the Wane,” Wall Street Journal, May 13, 1999, p. A2; and Tim Weiner, “House Speaker to Shift Tacks in Spending Bill,” The New York Times, June 5, 1999, p. A11.↩
Richard B. Freeman and William M. Rodgers, “Area Economic Conditions and the Labor Market Outcomes of Young Men in the 1990s Expansion,” NBER Working Paper No. 7093, April, 1999.↩
Economic Report of the President, Council of Economic Advisers, 1999.↩