It's A Whole New Ball Game, Mr. Greenspan

A new business cycle is shaping the U.S. economy. Wonder why inflation is so low after six years of expansion? Can't reconcile annual growth of over 3% with falling producer prices? Know how to connect low 5% unemployment and slow-growing unit labor costs? These mysteries can be explained largely by the emergence of a different kind of cycle, one dominated by information technology. The Federal Reserve should take note. Policy actions based on traditional analyses of the economy may now have unintended consequences. Viewed through this new analytical lens, the economy may be a lot more fragile than previously believed. A mistake in overtightening might plunge it into an unanticipated recession.

The business cycle changed under our noses. Suddenly computers, software, and communications became the engine of expansion, replacing autos and housing. In the past three years, the tech sector contributed 28% of the growth in GDP, vs. 4% for cars and 14% for housing.

There are two major implications. First, there's less of an inflationary threat than under previous cycles. A deflationary boom characterizes the high-tech sector, with falling prices generating higher sales and profits. Rising wages, in particular, have a far less inflationary impact in this cycle. The biggest wage gains in the economy are in software and computers--precisely where prices are falling. Alan Greenspan has suggested low wage inflation may be temporary, as once-anxious workers gain confidence in tight labor markets and demand more money. Maybe, but as the tech sector expands, rising incomes matched by higher productivity will not lead to more inflation--just a better standard of living.

In the short term, however, there is danger. The business cycle is clearly not dead, just changed. In fact, a cycle dominated by high technology can be more volatile than those based on traditional industries. Past high-tech expansions, such as the building of the railroads in the late 19th century, led to three decades of strong growth. But there were two financial panics followed by serious recessions along the way.

It can happen again, and soon. There is some evidence that the current cycle may already be peaking, and a high-tech slowdown may be under way. Consumer spending on computers is rising at its lowest rate since 1992. Unfilled orders for information technology equipment are falling. Semiconductor sales are down. Technology stocks have turned weak. Beneath the strong macroeconomic numbers, the high-tech driver of the new business cycle appears tired.

All the more reason for caution by the Fed. Relying on traditional business cycle measures, such as housing starts and retail sales, may lead to false impressions of strength. What is needed is a new series of measurements that track the high-tech business cycle as well as the traditional economy.

It may be that current weakness in high technology is merely temporary. Perhaps in the coming months, the global economy will pick up the slack in the high-tech sector, or the decline in domestic demand will turn out to be no more than a seasonal blip. But if the high-tech business cycle is aging rapidly underneath the current gloss of positive economic numbers, then the Fed had better be cautious in its actions. Interest-rate hikes big enough to puncture a "ballooning" stock market just might deflate an entire economy.

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