The End Of Conventional Wisdom
We stand humbled before this mighty American economy. Chugging into its seventh year of expansion, it continually surprises. No other business cycle has confounded experts and policymakers in so many ways. In its strength (growing an amazing 5.6% in the first quarter), stamina, and soundness, this economy defies conventional wisdom.
Let us count the ways.
Conventional wisdom says that an unemployment rate of 5.2% is below NAIRU, economists' term for the unemployment rate below which inflation starts to accelerate. Competition for workers at this low rate should be generating wage inflation, sending overall prices higher. Oops. The ECI, or employment cost index, rose a mere 0.6% in the first quarter and is up only 2.9% for the year. It was only yesterday that NAIRU was said to be 6.5%. How low can unemployment go? No one really knows. Sorry, bond market vigilantes.
Conventional wisdom says that a hike in the minimum wage should "infect" all wages, triggering inflation. Minimum wages are currently being raised, thanks to Congress and the President, but the biggest wage inflation in the U.S. is in high tech, where prices are actually falling. In the rest of the economy, steady growth is sucking in young workers, older discouraged workers, and new welfare workers, slowing "wage-push" inflation. Sorry, conservative economists.
Conventional wisdom says that corporate profits shrink when wages rise. They "always" do this late in the business cycle. Excuse us, but this time around, costs are under control, and corporate profits for the 900 companies on BUSINESS WEEK's Corporate Scoreboard rose 21% in the first quarter of 1997. Return on equity hit 17.5%, the highest in a decade. So much for mainstream economists.
Conventional wisdom holds that higher marginal tax rates curb economic growth and cut government revenues. They often do, but not when revenues are used to cut the budget deficit. Since Washington hiked the top rate on income tax in 1992, tax revenues have surged and the economy has prospered. Taxes raised to cut the budget deficit lowers interest rates and promotes growth, which generates tax revenues. The deficit is now down to $70 billion. Sure, it is better to shrink government and cut spending than it is to raise taxes. But when politicians won't offend their middle-class constituencies, raising taxes to cut deficits can work. Sorry, supply-siders.
Need we go on? The fact is that big changes in the dynamics of growth are turning the tenets of conventional economic wisdom on their heads. Globalization and high technology are changing the business cycle in unforeseen ways. There is little pricing power for corporations and hardly any for unions. The best explanation we have is that a new business cycle is determining America's destiny. Information technology is replacing autos and housing as the driving force in the economy, while global markets influence capital flows, price and wage pressures, and profits (BW--Mar. 31).
If the economic process is clearly different, its outcomes remain unclear. The Federal Reserve, to its credit, has generally been skeptical of conventional economic wisdom. Its monetary policies have accommodated the vast changes under way, and it has not panicked in the face of sharply falling unemployment. The Fed should continue to reject yesterday's shibboleths. In this strangest of times, all the evidence indicates that it pays to err on the side of growth.
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