SYNOPSIS: Warns that New Economy excesses may finally be catching up with it
Is that a police car, lights flashing, that we see in our rear-view mirror? For the last few years the U.S. economy has cheerfully broken all the old limits. And yet there have been no speeding tickets: unlike runaway booms in the past, this incredible expansion has not led to accelerating inflation. Instead, almost every fresh economic statistic has been a cause for celebration. Month after month productivity has risen more, unemployment has fallen further, and inflation has stayed more subdued than most reasonable people would have imagined possible only a few years ago.
It's already hard to remember a time when the U.S. business news wasn't good. Yet as recently as 1996 the economic headlines were mainly negative -- downsizing, not technology, ruled the front pages. And though it now seems hard to believe, Bob Dole's economic advisers insisted during the 1996 campaign that Bill Clinton's policies had produced only an anemic, disappointing recovery, and that only with the spur of big supply-side tax cuts could the economy recover its Reaganesque dynamism. (To be fair, critics of Mr. Dole's platform ridiculed his claim that he could achieve 3.5 percent annual economic growth -- a growth rate that the United States has consistently exceeded ever since he lost that election.)
Exactly why the old speed limits on the economy were so suddenly repealed remains something of a mystery. Productivity growth suddenly accelerated, probably because businesses started to make effective use of information technology, though we can only guess why infotech paid off so much in the late 1990's after producing such disappointing results in the previous 15 years. At the same time -- and therefore presumably for the same reason, though the connection is far from clear -- the economy developed a new immunity to inflation.
Before around 1995, the risks of inflation seemed clear in the data: inflation fell only when unemployment was high, as it had been in the early 1980's or early 1990's; inflation rose when unemployment was low, as it was in the late 1970's or late 1980's. And the break-even point, at which inflation neither accelerated nor decelerated, was an unemployment rate of around 6 percent. Who would have thought that unemployment could fall to 4 percent before even the first faint stirrings of inflation would be felt?
Alas, those stirrings are now being felt. Consumer prices are starting to rise noticeably, and competition for scarce labor is finally starting to push up wages. And the productivity number announced on Thursday fell somewhat short of our now exalted expectations. It's not that we're actually getting bad numbers. In fact, only a decade ago we would have been delighted to get results this good. But the numbers nonetheless are a warning that the economy's speed limit has been raised but not abolished, and that we have lately been going at least a bit too fast.
How high is the new, improved speed limit? The truth is that nobody can be sure because America's "new economy" is a very recent creation -- you have to base your guesstimates on only three full years of data. But it's starting to look as if the unemployment rate will have to rise a bit -- from 4 percent to say 4.5 if we're lucky, to 5 if we aren't. And growth will have to slow, from the 4-plus percent of the last two years to 3.5, maybe even 3 percent.
Will we be tempted to exceed these speed limits, even though they are much more expansive than the ones that confined us only a few years ago?
The would-be scofflaws are already complaining. Not a day goes by without some self-proclaimed economic expert indignantly denying that fast growth leads to inflation -- after all, how can producing more raise prices? The answer to this sophistry (I've never figured out whether these people are being deliberately dense, or just doing what comes naturally) is that it depends what causes the growth. If the economy grows rapidly because of an increase in supply -- say because workers have suddenly become more productive -- that lowers inflation. But if it grows because of an increase in demand -- say because of an exuberant stock market -- then the growth is indeed inflationary.
And that kind of growth -- which, it seems, is what we are now experiencing -- has to slow down.
Originally published in The New York Times, 5.7.00