Slider On The Black. Take a look at the speech given by the vice chairman of the fed reserve earlier this month. He discusses his view of the issues you raise on "stagflation" indirectly and adds a lot more. For any macro eggheads out there, this is compelling reading. The site is
federalreserve.gov
Here is an excerpt:
<<Monetary Policy and the "New" Economy
As I have said many times before, uncertainty about productivity trends poses a major challenge in the design and implementation of monetary policy. As you can imagine, it is very difficult to infer the true structure of the economy through the interpretation of the twists and turns of incoming economic data. How do we know, for example, if unexpected developments are just temporary movements away from stable longer-run relationships or are manifestations of changes in the underlying economic structure? In many cases, this judgment is difficult to make with much confidence even considerably after the fact. In the meantime, we must bear in mind that the statistical relationships we work with, embodied in our econometric models, are only loose approximations of the underlying reality. The considerable uncertainty regarding statistical constructs such as the "natural" rate of unemployment or the "sustainable" rate of growth of the economy suggests, in my judgment, the need to downplay forecasts of inflation based solely on those variables. Some fog always obstructs our vision, but when the structure of the economy is changing, the fog is considerably denser than at other times.
What should be done when such uncertainties seem particularly acute? When we suspect that our understanding of the macroeconomic environment has deteriorated, as evidenced by strings of surprises difficult to reconcile with our earlier beliefs, I think that the appropriate response is to rely less upon the future predicted by the increasingly unreliable old models and more upon inferences from the more recent past. That means we should weight incoming data more heavily than data from decades past in trying to make judgments about the new economy and, of course, act appropriately when the evidence becomes clear.
It also is important to be aware of the potential for unanticipated developments to emerge that might have implications for policymaking. The rate of growth of our economy has stepped down from the unsustainable pace of earlier this year. During such a period, potential risks emerge more clearly.
First, we must be mindful that an unexpected slowdown might occur in the growth of productivity. As I said, I am cautiously optimistic that the rapid pace of productivity growth can be extended. However, we now know that an unexpected and unrecognized slowdown in productivity growth occurred in 1973. The causes are still debated, but we know that the slowdown contributed to "stagflation," which emerged as employees demanded increased compensation, based on unrealistically high expectations of productivity growth and gradually rising inflation expectations, and employers granted those increases. To maintain profit margins, businesses then passed on those cost increases through to prices. This pass through occurred as the rate of growth in the economy subsided. This is the reverse of the good news that we have experienced in this expansion.
The second risk to good performance is that the investment boom, at least in some sectors, may overshoot. We are not only in the longest expansion in the history of our nation but also in the longest investment boom. Expectations of future returns from capital may not materialize, and companies may find that they have over-invested in capital stock. Other investment booms have ended with a pullback in investment that has slowed growth sharply, and we should be mindful that such an outcome is not impossible. Indeed, the recent releveling of the stock prices of some high-tech companies may suggest that we are entering a period of reduced optimism about future profits and less rapid growth in business investment.
The third risk is that the capital inflows from abroad that have been funding our domestic investments may dry up. The elevated stock market has reduced household savings. Net government saving has increased greatly, in the form of the surplus at the federal, state, and local levels, but as a nation we also rely on capital inflows from overseas. Capital inflows, as you know, are the counterpart of our record current account deficit. The gap between domestic savings and investment is large and growing, and if the inflow of foreign capital reversed suddenly, the consequences for our economy would be noticeable.
A fourth risk arises from ongoing adjustments in financial markets to the perception of a riskier economic environment. Over the course of this year, commercial banks have tightened their lending standards, and quality spreads have increased in the bond market--especially in the high-yield sector. Activity in the IPO market has subsided as equity investors have turned away from riskier ventures. Taking into account also the decline in equity prices since the spring and the rise in the foreign exchange value of the dollar, financial markets are imposing more restraint on the economy than they have in recent years. A reassessment of risks is a natural and desirable byproduct of financial market adjustments, and of returning to more sustainable economic conditions. There is always a danger, however, that participants will overreact in such a period of adjustment.
I do not today see such an overreaction, but we have to be aware that markets have turned excessively pessimistic in the past, with negative effects on economic activity. Similarly, although investment growth appears to have slowed, it is still rapid by historical standards and the dollar remains firm. Thus, I do not see, at this stage, evidence of a marked drop off in investment or of a sudden reversal in capital flows. However, it is prudent to be mindful of these risks in this transition period.
Conclusion
In conclusion, let me remind you that, while these are challenging times for monetary policymakers and financial market participants, the U.S. economy is enjoying a period of unprecedented prosperity. Our job at the Federal Reserve is to do our utmost to produce a stable economic environment of maximum sustainable growth without inflation so that these trends can continue. To produce such an environment we must be equally vigilant against the risk of either an extended period of growth unacceptably below potential, or a resurgence of inflation. >> |
