Macroeconomic Implications of the "New Economy"
J. Bradford DeLong
Over the past decade it has become increasingly clear that innovation in computer and communications technologies is proceeding at an extraordinary pace. The pace of technological advance is well-described by what has come to be called "Moore's Law"--the rule of thumb that Intel cofounder Gordon Moore's set out a generation ago that the density of circuits we can place on a chip of silicon doubles every eighteen months with little or no significant increase in cost. Moore's Law has held for thirty years; it looks like it will hold for another ten at least. Moore's Law means that means that todays computers have 66,000 times the processing power of the computers of 1975. In ten years computers will be more than 10 million times more powerful than those of 1975--at roughly constant cost.
In a normal case one would say that rapid improvements in a particular branch of industry run into diminishing returns. The first candlepower of light one can produce after dark--with a candle or an oil lamp steady enough to read by--is a really big deal. The ten-thousandth is not. But each upward leap in computer processing power seems to bring a new dimension of capabilities and uses: the first computers produced tables useful for calculating artillery trajectories. The next generation were used not to make sophisticated but to make the extremely simple calculations needed by the Census Department and by the human resource departments of large corporations. The next generation of computers were used to stuff data into and pull data out of databases in real time--airline reservations processing systems and insurance systems.
Computers came to American business as wordprocessors and what-if machines, devices to answer questions like "what if this paragraph looked like that?" or "what if the growth rate were twice as fast?" And now computers have become embedded into objects as sensors and controllers, and extended from machines to access the worldwide library that we are now building. For paralleling the revolution in data processing capacity has been a similar revolution in data communications capacity.
I won't say whether this particular leap forward in technology is larger than in the past--bigger than the steam engine or the automobile. How could I? What metric would we use? In their day television, or the internal combustion engine, or the railroad, or the steam engine were technological leaps that transformed the economy as well. And you only have to begin thinking about the problems of measuring changes in economic structure and rates of economic growth across structural transformations before you conclude that the problems of measurement are as unsolvable as the problem of trying to draw an accurate two-dimensional map of the surface of the earth.
Today I am going to focus on a subset of these issues: what this "new economy" means for macroeconomic policy--even though it may well be the case that the microeconomic effects (on antitrust doctrines and policy, say) are more important.
So I have six points to make here today:
- First, that computer technology finally is a big deal for the macroeconomy as a whole
- Second, that computer technology is almost surely a bigger deal than our standard measurements suggest.
- Third: one macroeconomic consequence is likely to be a decline in the inventory cycle.
- Fourth, a second macroeconomic consequence is likely to be an improved labor market--the one we are seeing now.
- Fifth, that macro policy becomes more difficult because rules of thumb break down.
- Sixth, that someday macro policy will become even more difficult because the tools of monetary policy may--not now, but at some date in the distant future--lose a lot of their power.
Computer Technology Finally Has a Large, Direct, Measured Effect on Growth...
A decade or more ago it became a commonplace to wonder where the aggregate macroeconomic benefits of computers were. Back then Dan Sichel had an answer: the economy was large, and in that context computer investment was small.
But now computer investment is large. The end of the government's budget deficit and the rising inflow of capital from abroad have boosted total investment--and at the margin one of every two new investment dollars goes to information technology. And the price of computers has fallen, so each dollar of nominal investment in information technology buys much more computer power today than it did a decade ago.
Dan Sichel and Steve Oliner conclude that eighty percent of the acceleration in measured productivity growth in the second half of the 1990s is due to information technology investment.
But Other, Unmeasured Effects May Be as Large...
Moreover, there are large chunks of the economy in which productivity growth is not well-measured at all. Many of these chunks are ones in which we would expect computer investment to yield substantial gains. Are we measuring them all? The conclusion has to be "no." As Alan Blinder has written, "retailing over the Internet may offer many benefits to consumers (examples: cheaper comparison shopping, 24-hour availability, no travel costs, etc.), but such gains will never be counted in GDP, and hence will never appear in the productivity statistics."
However, there are no firm, reliable numbers on the magnitude of official statistics' understatement of productivity growth. There are only guesses. The Boskin CPI Commission had a guess of about 1% per year, but even they did not speculate on whether the magnitude of the understatement was growing.
Consequences: The Decline of the Inventory Cycle?
Managers say that one of the principal benefits of new computer-and-communications technologies is better inventory control. Businesses today can control their inventories much more effectively. Interest and storage costs are lower. Stock-outs are less frequent, and less costly.
What are the macroeconomic implications of better microeconomic inventory management? Over the past hundred years, as much as two-fifths of the quarter-to-quarter variability of production growth rates about trend has been due to fluctuations in inventory investment. Already we have seen economy-wide reductions in inventory-to-sales ratios of about one-fifth, and greater reductions in the length of time goods spend in the inventory pipeline.
If the reduction in inventories made possible by modern information and communications technologies is close to reaching its limit, then we can expect that one consequence of the new economy is to moderate the inventory-driven portion of the business cycle. If the reduction in inventories has just begun--if improved information flow will truly make the new economy a just-in-time economy--then we can expect that the inventory-driven portion of the business cycle will be severely reduced, or effectively eliminated.
Consequences: A Lower "Natural Rate" of Unemployment?
The use of unemployment as a measure of cyclical conditions has gone awry at least twice: in the late 1970s, as the natural rate rose, and in the late 1990s, as the natural rate has fallen. In the late 1970s belief that there was still room for substantial expansion without accelerating inflation proved false: the actual natural rate of unemployment turned out to be higher than believed by two percentage points. In the late 1990s belief that there was no room for substantial expansion without accelerating inflation proved false: the actual natural rate of unemployment turned out to be lower than believed by two percentage points.
One way to interpret these facts is to say: "too bad for natural rate theories." Stable natural rate theories worked well only in the U.S.--they never worked well in Europe, for example. So why should we be surprised that their success in the U.S. is only temporary and transitory?
A second thing to say is that workers' real wage aspirations are a function of the unemployment rate: the higher is unemployment, the smaller is the amount by which workers aspire to raise their real wages. In equilibrium, the rate of unemployment consistent with non-accelerating inflation--the natural rate of unemployment--will be that rate of unemployment at which workers' real wage aspirations are equal to economy-wide productivity growth.
Thus the higher the rate of productivity growth, the lower the natural rate of unemployment.
This wage-aspiration theory is certainly a candidate explanation for both the surprisingly unfavorable inflation-unemployment tradeoff the U.S. experienced in the 1970s, and the surprisingly favorable inflation-unemployment tradeoff the U.S. has experienced in the 1990s. If it is correct, the low current natural rate is another benefit that the U.S. is reaping from the new economy.
Consequences: A Broken Speedometer?
But the "new economy" has bad as well as good consequences for the making of monetary policy. For one thing, when historical patterns no longer apply standard rules of thumb no longer apply either. In the absence of standard rules of thumb, it becomes more difficult to try to guide the economy into the narrow zone in which price stability and full employment are both attainable.
How to make Federal Reserve policy with a broken speedometer is a very hard problem. More weight has to be placed on the immediate past and less weight on the distant past in deciding what to do. But it is not clear to me how to think constructively about such issues.
Consequences: Do Traditional Tools of Monetary Policy Break?
The last of the consequences I wish to note is that perhaps the new economy will--not now, but someday--break the standard tools of monetary policy. The Federal Reserve uses its open market operations--sales or purchases of U.S. Treasury securities for reserve deposits at the Fed--to manipulate interest rates and so affect aggregate deamnd The unique role of commercial banking reserves in the payments system means that small open market operations have large consequences for the intertemporal price structure. The Federal Reserve controls interest rates remarkably easily.
But this will hold true only as long as deposits at U.S. commercial banks are the means of payment of choice in the economy. And as financial innovation proceeds and as the new economy grows, there is a good chance that deposits at U.S. commercial banks will cease to be the means of payment of choice.
And if this happens, what becomes of the Federal Reserve's ability to control interest rates and affect aggregbate demand?
So far there is no sign that the unique role of bank reserves in the U.S. payments system is fading away. There are no signs that Federal Reserve power to shape interest rates is diminishing. But someday there may be.
Conclusion: Other Issues
And there are a host of macroeconomic issues I haven't considered: Day traders. Contagion. The magnitude of the peso and East Asian financial crises.
But I've talked for long enough, and should stop.