Last summer, Federal Reserve Chairman Alan Greenspan stunned Wall Street by raising a provocative issue: Is the high-tech boom a "once or twice in a century phenomenon" that's altering the old rules for how the economy operates?
Coming from a central banker who epitomizes sober economic analysis, this question was remarkable. While Greenspan admits it may be another decade before the Fed fully understands the economic changes now afoot, he is increasingly convinced that huge business investments in new technologies allow the economy to grow faster--and longer--with less risk of inflation.
While the Fed chief eschews such buzzwords as "New Economy," he doesn't understate the significance of the changes. The current expansion, he said in June, is "as impressive as any I have witnessed in my near half-century of daily observation of the American economy."
Greenspan's conversion from inflation hawk to leading proponent of the new economic rules is having enormous impact on monetary policy. In the past, the Fed would have already slammed on the brakes to prevent an inflationary spiral. Over the past three years, by contrast, it has raised rates just once. And with Asia's economies still in free fall, Greenspan may decide that the Fed's correct course now is to provide liquidity to the rest of the world.
X-FACTOR. Even if Asia were to stabilize tomorrow, he may conclude that the economy's higher growth potential allows him to wait for more evidence of inflation before raising rates. Although Greenspan won't say precisely how fast productivity is rising, he believes it's somewhere above the 1% rate that the U.S. has averaged since the 1970s but below the 2% rate of recent quarters.
It's not just capital spending that's behind the productivity gains, in Greenspan's view. He also sees a parallel revolution in the workforce--an X-factor that may explain why wages haven't risen faster. Greenspan believes today's workers, seared by waves of downsizings, suffer chronic job-obsolescence fears. So they're more flexible, willing to learn new skills, and less prone to job-hop for a few more bucks.
Corporate managers, meanwhile, are smarter in how they invest in new machinery--boosting the "efficiency of capital," as Greenspan puts it--even while using new management practices to redesign their businesses. "Total quality management, customer satisfaction...we've got a whole generation of executives who are thinking differently," says Fed Vice-Chair Alice M. Rivlin, who agrees with Greenspan on this point.
Still, Greenspan hasn't let his guard down on inflation. While technology's potential may be limitless, the labor supply isn't. At current growth rates, he knows the economy will eventually run out of workers--and drive wages up. Indeed, Greenspan may agree to nudge rates up this fall if the economy shakes its summer slump.
But even a rate hike won't take away from Greenspan's amazing balancing act: his ability to adapt to the pervasive ongoing changes in the economy while still standing strong against inflation. In the end, his greatest legacy will be a high-growth, low-inflation economy.