July 09, 2002
Macroeconomic Vulnerabilities in the Twenty-First Century Economy: A Preliminary Taxonomy

And the fourth of the four things I had hoped to finish by mid-May is finally put to bed. Now it's time to get back to revising Slouching Towards Utopia.

"What is this fourth thing?" you ask. It's a paper for the a Council on Foreign Relations conference. It's an attempt to think coherently about how the information technology revolution is changing macroecononomic points of vulnerability:

It seems to me highly likely that five sets of factors will be most important as changes in economic structure carry with them changes in points of macroeconomic vulnerability over the next one to three decades. These five sets of factors fall into two groups: first, likely changes in the magnitude of macroeconomic shocks; second, likely changes in the ability of government to act to neutralize or damp the effects of macroeconomic shocks.

The likely changes in the magnitudes of shocks are two, and they work against each other:

  • First, the faster productivity growth and the greater uncertainty associated with a leading sector-driven boom increases the likely magnitude of asset market shocks. Sectors or the aggregate market are more likely to find themselves substantially mispriced. Either waves of euphoria, or the reaction when it turns out that the profits flowing from technological advance have been overestimated, are likely to cause larger-than-usual shifts in the location of the IS curve.
  • Second, if information technologies really are information technologies, then inventories should behave better in the future than in the past. To the extent that a large share of past business cycles have been caused by "mistakes" in inventory accumulation and decumulation because of a lack of rapid information transmission from final demand to the factory floor, information technologies should reduce the size of this inventory component of the business cycle.

Then there are the likely changes in the responsiveness of policy to macroeconomic shocks:

  • Third, a technology-driven boom itself may well degrade the government's ability to carry out successful macroeconomic management. The end of a period of high euphoria and extravagant boom will inevitably bring a reduction in investment, and managing the resulting necessary expenditure-switching is a delicate task made more difficult because, as Larry Summers has pointed out, a euphoric boom is a period during which people stop thinking as intensely about problems of macroeconomic management.
  • Fourth, faster aggregate productivity growth good not just in itself but likely to improve the functioning of the labor market. To the extent that one attributes a large part of Europe's macroeconomic problems over the past generation to the interaction of the productivity slowdown of the 1970s with labor market structure, one would expect an acceleration of productivity growth to pay enormous business-cycle benefits as well--and it seems very safe to bet that the current ongoing technological revolutions will produce rapid productivity growth for quite some time to come.
  • Fifth, difficulties of surveillance with increasing financial market complexity. To the extent that a principal goal of economic policy is to keep chains of large-scale bankruptcies from disrupting the financial sector, it is essential for government regulators to understand the capital structure and the portfolio risk profile of financial services firms. This appears to be becoming more and more difficult.

For the full text:

Macroeconomic Vulnerabilities in the Twenty-First Century Economy: A Preliminary Taxonomy


Posted by DeLong at July 09, 2002 03:31 PM

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This is really weird. I dreamt last night that I ran into Brad DeLong on a trip to Europe and asked if "Slouching Towards Utopia" had finally been published (has it? I tried to find it on Amazon months ago).

Shows you how bad the effects of frequently checking this site can be.

Posted by: Wolf on July 9, 2002 04:36 PM

In footnote 1, you list 20th century macro vulnerabilities, but you omit the "oil shock" of the 1970's. I'm curious as to why. Also, I'm curious as to an example of an inflation caused purely by loss of central bank reputation. I can't think of one--doesn't mean it hasn't happened.

In looking ahead, I think you ought to pay attention to the increased relative importance of general human capital as opposed to firm-specific human capital. I think that makes it easier for people to change jobs in a downturn, and therefore makes downturns less severe.

Also, I think that the greater complexity of the economy and greater variety of goods should increase elasticities of substitution. That should make the economy less vulnerable to shocks to any particular sector.

My $.02

Posted by: Arnold Kling on July 10, 2002 12:14 PM

Your point about the run-up in stock prices raising doubts about the ability of the stock market to allocate capital rationally is a good one. I had worries about this as far back as 1997, not because of the irrationality of the stock market so much as the fact that in the information age it is people, not machines, that require efficient allocation. It would be a surprise--almost a coincidence--if a market that grew up around allocating machines and factories could turn out to be the best mechanism for allocating people.

Posted by: Arnold Kling on July 10, 2002 12:26 PM

Professor DeLong,

Not that you should mind front page status in the WSJ, but do you think Mr. Wessel has done your “Taxonomy” piece a disservice? My impression of your article is that you were quite clear in saying you were pointing out things that are likely to affect the volatility of economic performance and which may make performance more volatile, thereby complicating economic management. (Scrooge wants to know whether this is a future that might be, or will be.) The WSJ article seems to imply (very strongly in the title) that your “Taxonomy” draws conclusions, that economic management will become more difficult, economic performance more volatile.

On the question of whether the future will be harder to manage than the past, let’s assume there is some continuity in technological change, though progress may be rapid, and that financial markets likewise evolve but that there are no serious discontinuities (this latter point is a stretch, I know). Assuming such continuity, then the near future may look a bit like the recent past. During a period of rapid technological change, the volatility of US economic performance has declined, starting around 1984. During that same period, there has been a rise in the volatility of equity prices. Even if one does not accept your 150 year comparison as valid, the comparison of the past 20 years seems to address the "rapid technology change, volatile financial markets" issue.

When it comes to emerging economies, things are quite different. If the recent past tells us anything about the future for emerging economies, it is that they become vulnerable to new shocks just as they are learning to handle the old ones. If anybody’s record warns of trouble in an environment of rapid change, it is that of emerging economies.

Posted by: K. Harris on July 18, 2002 08:32 AM

It's true that Wessel read the paper as more on the "increased volatility" side than I had thought I had written, on reflection I think he's right: the stabilizing inventory point is, so far, theoretical only...

Brad DeLong

Posted by: Brad DeLong on July 18, 2002 08:31 PM
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