Commentary: Why The Economy May Be Safe At Higher SpeedsRich Miller
When Federal Reserve Chairman Alan Greenspan delivered a paean to productivity on June 13, New Economy enthusiasts cheered. He could have focused on the fact that consumer confidence has been high or that higher oil prices could ultimately prove inflationary. Instead, the Fed chief chose to use his speech to New York economists to extol the virtues of the continuing boom in productivity. Says Edward Yardeni, Deutsche Bank's chief economist and a New Economist: "It brought tears to my eyes."
And knowing smiles to the lips of a small but growing group of Fed policymakers, including Greenspan confidante and New York Fed President William J. McDonough Jr. These proponents of a cautious approach on interest rate hikes suspect that the economy's so-called speed limit--the rate at which it can grow without igniting inflation--can be ratcheted up again. The reason: continually strong productivity growth, which jumped 3.7% in the first quarter over the same period last year. The new approved growth rate is thought to be somewhere between 4% and 4.5% annually.
That's not too much slower than the 5.4% annual growth rate the U.S. chalked up in the first quarter, and it is markedly faster than the 3.5% speed limit the Fed imposed on growth just six months ago. More important, it matches most estimates for growth in the second quarter. The implication: For the moment at least, the Fed's job may be done when it comes to interest rate hikes. This is not to say that the central bank could not move again--some see the potential for the economy to heat up in the second half. But for the June 27-28 meeting and for as long as there's no reversal of the slowing trend, the Fed may be able to rest on its laurels.
While Greenspan has shied away from publicly endorsing any specific targets for growth, Fed insiders describe him as sympathetic to notions that the economy's sustainable cruising speed has increased again. More surprising, however, is the support the higher speed limit is receiving from some of the Fed's most ardent inflation hawks, such as J. Alfred Broaddus Jr., president of the Richmond Fed. Just this month, he acknowledged that "an increase in the underlying trend growth in productivity may have increased the economy's speed limit to 4% or higher."
But don't think that everyone at the Fed is convinced that the economy has safely shifted onto a higher plane. Fed Governor Laurence H. Meyer puts the economy's cruising speed at about 3.75%, and argues that growth must be slowed to below that rate for inflation to be brought back in check. The key statistic for Meyer: a 4.1% unemployment rate, still among the lowest in a generation.
Regardless, there's no mistaking the signs of a new confidence in the economy's durability. And corporate chieftains, judging by where they put their money, seem to agree. U.S. companies continue to shell out billions for computers and other high-tech gear to enhance efficiency. Proving just how strong demand is for such productivity boosters, the Fed said on June 15 that the production of computers, communications equipment, and semiconductors was nearly 50% higher in May than a year ago. That kind of increase this late in an expansion cycle once seemed almost impossible.
B2B EXPLOSION. In addition, the Fed is also encouraged by reports that companies are putting the technology they already have to better use. Case in point: the Internet. While there was a period in which companies were experimenting with having a presence on the Net, they now are increasingly using it to slash purchasing costs and, of course, add to their productivity. A survey by consultants ActivMedia Research found that B2B Web sites expect revenue to grow by nearly 260% this year--and a further 160% next year.
Putting it all together, it's no wonder some Fed policymakers sound more upbeat. In the short run, there will be a slowdown, they say. And the longer-term prognosis, based on the enduring nature of productivity gains, seems to support a much extended run for the New Economy. For Greenspan & Co., that's about the best news could receive.