Time to Rest Our Tired Economic Dogmas
The pundits are puzzled. Something must have changed! How otherwise can we explain:
* Real gross domestic product up at an annual rate of 3.6%, according to preliminary estimates for the quarter ended June 30.
* The average rate of growth rising to 3.4% over the last year, to 3.3% over the last two years, and to 3% over the last four years.
* Unemployment at or below 5% for five consecutive months and below 6% now for three full years.
* The producer price index rising only 0.3% in August (the core rate, excluding volatile foods and energy prices, rising only 0.1%) after actually falling for seven consecutive months.
Old dogmas, which had become conventional wisdom on Wall Street and among the Federal Reserve Board governors and all too many economists, declared this could not be. Maximum growth was supposed to be 2% to 2.5%. And only a few of us who supported the old (1978) Humphrey-Hawkins Act target of 4% unemployment believed these unemployment rates possible.
If by some miracle--or fiscal stimulus package from the administration and Congress, or monetary stimulus from the Fed--this faster growth and lower unemployment were to be achieved, it could only come with more inflation. Indeed, not merely more inflation, but “accelerating inflation"--inflation getting faster and faster as long as the economy was doing too well or was “overheated.”
Faced with current reality, the new crop of revisionists tell us they were right in the past but somehow--not entirely clear even to such an astute observer as Alan Greenspan--the economy has changed. Perhaps because of new technological advances in the emerging Information Age, productivity growth really has increased, although government figures have been slow to show it.
Perhaps we would have accelerating inflation if it were not for the new globalization of economies and the pressure of international competition. Perhaps our good fortune is due to the exceptionally wise policies of the Clinton administration and the consequent achievement of virtual balance in the federal budget--or was that due largely to the more rapid growth itself? Or perhaps the chairman of the Fed, despite his admitted puzzlement, is himself the explanation.
Or maybe, just maybe, while our economy is undoubtedly changing, the laws of economics have not changed. Maybe we were always capable of more rapid growth and lower unemployment without undue inflation and we failed to achieve it because of our own misguided policies.
In my 1994 book and in many professional articles, I attacked the concept of the natural or “non-accelerating inflation rate of unemployment” (NAIRU), which was blocking policy to move the economy on a faster path. I have closely analyzed the data of the last 40 years and concluded that although high unemployment has apparently contributed to lower inflation, low unemployment has not raised it.
One explanation is that the low unemployment of a brisk economy is itself associated with higher productivity, as existing resources are put to fuller use. Almost 3 1/2 years ago on this page, I attacked efforts to “combat an inflation that nobody can find.” I then attacked the premise that “the economy is doing too well! If we don’t slow it down and hence keep unemployment from getting below 6.5% . . , we shall have that accelerating inflation.”
There was an old doctrine in economics referred to as Say’s Law, which asserted that “supply creates its own demand.” This was taken to mean that in a free-market economy we need not fear oversupply and consequent unemployment. That doctrine was challenged by John Maynard Keynes, who pointed out against the backdrop of the Depression that business had found no demand for what it was supplying--and output and employment plunged as a result.
I would turn that old phrase and say that, to a very considerable extent, demand creates its own supply and has always done so. Full purchasing power and demand bring the economy up toward capacity and induce the investment and technological advance that permit further growth.
We must hence eschew tax increases to balance the budget, such as those in 1990 that destroyed people’s faith in the lips of George Bush as well as his reelection chances as the economy slipped into recession. And we must eschew the “peremptory strikes” that inflation hawks want from the Federal Reserve.
Let us shed our puzzlement. The fundamentals may not really have changed. And now, as it should have been over the years, the words for our economy should be “Full speed ahead!” We deserve nothing less.