Not so long ago, Federal Reserve officials were telling the public that productivity gains had lifted the U.S. economy's potential growth rate in the 1990s to a healthy 3.5% to 4% range. Recently, however, they have hinted that even that relatively optimistic assessment may be too conservative.
Last month, Robert T. Parry, president of Federal Reserve Bank of San Francisco, opined that the economy's potential growth rate this year and next was 5%. After standing firm on interest rates at its August meeting, the Fed's open-market committee pointedly noted that "more rapid advances in productivity have been raising potential growth, as well as containing costs."
And of course, at a Fed conference in Jackson Hole, Wyo., several weeks ago, Fed Chairman Alan Greenspan struck a new note in his paean to the New Economy. Citing the stepped-up pace of high-tech investment, he suggested that productivity growth may well continue to accelerate in coming years.
What's inspiring this unbridled optimism? Noting Greenspan's caution and insistence on detailed economic analysis, two seasoned Fed watchers, economists Peter Hooper and Trevor Dinmore of Deutsche Bank, believe the Fed is relying on more than the latest productivity data. "Greenspan and company are looking at some hard evidence," say Hooper.
In a new study, Hooper and Dinmore analyze the implications of the key evidence they think the Fed is using--a recent paper by two Fed staffers, Stephen D. Oliner and Daniel E. Sichel. The paper found that the U.S. business stock of information-technology capital (computers, software, and communications gear) soared throughout the economy in the late 1990s. The result was a sharp rise in capital-labor ratios, which, the Fed staffers estimate, boosted worker productivity growth by a full percentage point between the first and second halves of the 1990s.
Hooper and Dinmore extend the Oliner and Sichel economic model to focus on what has already happened this year and what lies ahead in 2001. They find that the growing tech capital stock alone is adding around 1 3/4 percentage points to productivity growth this year and next. As a result, the economy's sustainable growth rate is around 4.5%--and could be even higher next year.
In short, says Hooper, productivity-enhancing IT investment is continuing to raise the economy's "safe" speed limit. As long as such investment stays strong--and underlying inflation stays subdued--it's likely that the Fed will be slow to step on the monetary brakes.