How the fed does it, a FT article, could be very funny tomorrow, then again, maybe not...(doomsville about one little number a tad overdone, imo, and god, the wait!!!...death by bicycle!)
And, no, it's not Rivlin's swan song. Was in the online addition a few weeks back:
FED: Greenspan re-thinks policies
Greenspan is adjusting his policies in a world where inflation seems dead,
says Gerard Baker
Behind the unblinking facade of the US Federal Reserve's headquarters in
Washington they are cleaning house. From top to bottom of the venerable
institution, shelf-loads of tools and measures of monetary policy are being
dusted down, reconditioned or even cast aside.
The Nairu, a faithful appliance that has monitored monetary policy since the
1970s, is being consigned to storage. The Expectations-Augmented Phillips
Curve, an attractive, if baroque, piece of economic furniture, is deemed no
longer safe for policymakers' use. Even that family jewel, the Taylor Rule,
is getting some long, hard looks from the repairers.
This is because some of these tools indicate that the US economy - after a
prolonged expansion - should be dangerously close to overheating. They
suggest that Alan Greenspan, chairman of the Fed, should be tightening
monetary policy to avoid an outbreak of inflation.
Inflation remains firmly under control even as the economy expands. And the
men and women of the Fed responsible for monitoring it and keeping it on a
sustainable track are acknowledging that their traditional methods may no
longer work.
The search is now on for analytical tools that might work better. So far,
officials have not abandoned tried-and-tested formulas for interpreting the
economy's signals. But a far-reaching intellectual inquiry is under way into
the basis of monetary policy decision-making.
"I don't think we really have a lot of clues," Alice Rivlin, the vice-chair
of the US central bank, said in an interview last week. "The
macro-statistics may not be all that much help. People who want to
understand this may need to pay a lot more attention to what is really going
on in businesses and labour markets."
In its unprecedented growth spurt over the past three years, the US economy
has broken several rules: first, history says sustained growth above the
economy's long-term trend will inevitably end in higher inflation.
For three years, the US has grown at an annual rate of just under 4 per
cent - 1.5 percentage points above the long-term trend. Yet the main measure
of overall inflation, the gross domestic product price deflator, has fallen
steadily - to an annual rate of 0.8 per cent in the last three months of
1998, its lowest in more than 20 years.
Second, theory suggests that a fall in unemployment below a certain level
will lead to a spiral of accelerating wage and price inflation as demand for
workers forces employers to pay higher wages, without a corresponding
increase in output.
In the past few months, the unemployment rate has fallen to 4.2 per cent,
its lowest level in 30 years and well below what even the most sceptical
economists regard as the lowest rate consistent with stable inflation. Yet
average annual earnings growth has been little changed in the past year and
is now just 3.6 per cent; consumer price inflation is 1.7 per cent per year,
half what it was three years ago.
Third, experience indicates that low unemployment leads also to declining
productivity, or output per hour. As employers hunt for workers in
increasingly tight labour markets, the quality of the people they are able
to hire diminishes.
But even as unemployment has declined, the rate of productivity growth has
doubled in the past two years, from its sluggish rate in the early 1990s, to
over 2 per cent now.
Outside the Fed, some analysts have used these events as evidence that the
US economy has entered a "new paradigm" - a fundamental positive shift in
conditions in the past few years that will enable it permanently to grow
faster than its historical trend.
Not even the most optimistic of the policymakers on the Fed's Open Market
committee, which sets short-term interest rates - admit to being converts to
the new paradigm. Nor is anyone quite ready to cast aside completely the
traditional policy tools.
This may be partly because even policymakers who sympathise with the notion
that something fundamental has changed would not dare say it in public.
The Fed's pronouncements are so closely scrutinised that any admission would
be seized upon by the markets, with unpredictable results.
But officials also appear to be genuinely undecided about what is happening.
Even some of the more sceptical policymakers confess to bafflement at the
apparent breakdown in traditional rules. They admit to waning confidence in
the view that the strong performance is all down to a number of "lucky
breaks" - such as falling global commodity prices or declining healthcare
costs.
As a result, the Fed has resisted pulling the interest-rate trigger for most
of the past two years, even as inflation warning lights have been flashing.
Officials are at least prepared to allow the possibility that something
radical might have changed.
"This will perhaps be remembered as Greenspan's greatest strength", says
Richard Medley, of Medley Global Advisers, a policy consulting company, who
studies the Fed closely. "Here he is, a 72-year-old man who remains
completely open to re-thinking the way the world works."
One reason for this re-thinking is an unusual divergence between conditions
in labour and product markets. Labour markets have grown tighter in the past
few years, reducing excess capacity in the form of workers looking for jobs.
Yet productive capacity use has actually fallen. Industrial capacity
utilisation - at around 80 per cent - is now down to near recession levels.
In other words, while employers will have difficulty in drawing down much
further from the remaining pool of unemployed labour, it is equally clear
that they could in principle expand output without experiencing potentially
inflationary production bottlenecks.
The critical aspect of this phenomenon is that it goes some way towards
explaining why productivity might have improved significantly in the past
few years.
Big investments - especially in information technology-related equipment -
have raised the output per hour produced by each worker.
This improvement is a key factor in the benign inflationary environment.
Higher productivity enables companies - and the economy as a whole - to
produce more without raising prices.
In addition to this phenomenon, some economists argue that US companies have
changed their behaviour in response to the intensification of global
competition in recent years.
Because of fierce pressure at home and abroad, companies are increasingly
unable to raise prices for fear of losing market share. Instead, they have
had to find different ways of dealing with the cost pressures they face.
Ms Rivlin last week offered one possible explanation that links these two
phenomena. She argued that increased global competition to hold down prices
may have induced a radical change in companies' behaviour.
Instead of pushing up wage inflation, tight labour markets may actually have
reduced it by encouraging companies to invest more in plant and technology
and in the training of their workers. That may have raised productivity, and
held inflationary pressures in check.
Ms Rivlin emphasised that this was merely a possibility, not a confirmed
fact, and some other Fed insiders are sceptical. But there does seem to be a
growing belief among policymakers that something quite important - the
potential of the US economy for achieving sustained productivity growth -
has changed.
As Robert Parry, the head of the San Francisco branch of the Fed said last
week, the evidence is more persuasive than ever that an upward shift in
output per hour has occurred in the past three years. Many economists
doubted the reliability of the productivity figures, but the improvement now
seems to be so marked that attempts to explain away the change now seem less
convincing.
You do not have to be a believer in some dramatic "paradigm shift", say some
senior Fed officials, to believe this change could be important. It may be
that productivity improvements have raised overall growth potential by some
relatively small amount - say by half a percentage point per year.
If that is what is happening, then it suggests a possible alternative to the
new paradigm. The new paradigm implies that the US is moving from the old
world of hard choices and policy tradeoffs to an nirvana of inflation-free
growth.
Under the alternative view, the old rules may not work for now. But this
nirvana will prove simply to be a transition, and the US economy will
eventually face settle down at a new period in which it will again face
trade-offs between price stability and growth.
In other words, the economy will not go on for ever, functioning as benignly
as it has done in the past three years. At some point the old rules will
reassert themselves, but simply at a slightly higher rate of growth.
That implies that Fed officials should not throw away all the old analytical
appliances just yet. They may need to be tweaked and adjusted to reflect the
way the world has changed. But eventually, their day will come again.
Nancy, most definitely not for tweaking Phillips' curve...
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