In economic history, great myths are
often made and sustained not so much by the difficulty of the subject
matter, but by the failure of the discussants to look at the readily available
data. America's longest business cycle expansion, which has now been officially
certified as running from March 1991 to March 2001, is a case in point.
In the folklore of the business press, a widely held explanation has already
congealed for the upswing that led optimists to proclaim the emergence
of a "new economy."
The now conventional wisdom flows as follows: together with Congress,
the Clinton Administration got the ball rolling by balancing the federal
budget, and moving it towards surplus. This caused long-term interest
rates to fall, which led to an investment boom--especially in the high-tech
sectors--and stimulated such interest-sensitive purchases as housing.
All that new investment caused productivity to grow by leaps and bounds.
Since productivity the amount of goods or services that an hour of labor
can produce--is the basis of economic growth, this raised incomes across
the spectrum.
The virtuous circle was completed by the response of the Federal Reserve:
because of the surge in productivity, we are told, the Fed didn't have
to worry about rapid growth leading to accelerating inflation. Thus the
Fed was able to lower short-term rates, and allow for a record-long expansion,
with unemployment falling to a 30-year low of 3.9 percent.
Sounds plausible, doesn't it? And familiar. Now let's look at the numbers.
Over the course of the business cycle, real (inflation-adjusted) interest
rates on mortgages and high-grade corporate bonds fell by only 0.8 percent.
This certainly doesn't look like enough to stimulate an investment or
housing boom, and it wasn't.
Housing barely increased at all, as a percentage of the economy. And if
we look at both investment components of GDP (investment plus net exports),
the investment share actually declined slightly.
Productivity growth did increase, as compared to the business cycle of
the 80s. But it was still considerably lower than the growth of the 50s
and 60s business cycles. If we adjust for the increased share of output
that was used up in more rapid depreciation--mostly computers and software--the
productivity growth of the 90s cycle does not even beat the 70s. And wage
growth for a typical worker was a paltry 0.5 percent a year.
So much for the "new economy." Still, it was a long expansion,
and a pleasant memory compared to what we are facing right now. So what
was behind it, if the official story doesn't hold up to the numbers?
Most importantly, there was a consumption boom that was driven by an enormous
bubble in the stock market. Personal savings rates fell to zero as upper-income
householdsthe ones that hold stockssaw the value of these assets soar.
The Fed's change in policy allowed the expansion to continue. Prior to
1995, it would slow the economy when unemployment fell below 6 percent,
on the theory that this was the best we could do.
But this drastically important policy change--even today, we have millions
of additional jobs as a result--could have been made at any time. It was
not a result of 1990s productivity increases, but rather the Fed's belated
realization that its prior theory was wrong.
Understanding the 1990s expansion, and its collapse, is vitally important
to getting us out of the current recession. The evaporation of $8 trillion
in stock market wealth translates into more than $300 billion in reduced
consumption.
This means we need a stimulus package more than twice as large as the
one that Senate Democrats are proposing (the House Republican plan contained
hardly any stimulus at all, consisting mostly of tax breaks for corporations
and high-income households).
Diehard policymakers and economists including many Democrats still cling
to the notion that fiscal conservatism brought us prosperity. They ache
to resume paying off the entire national debt at the earliest opportunity.
Many others welcome the re-inflation of the stock market bubble--which
still exists, and has lately been growing.
And while the Fed has been doing the right thing by lowering interest
rates since the slowdown began, it could still revert to its old ways
before the recovery is on track. This is especially true if our overvalued
dollar--another largely unnoticed bubble from the 1990s expansion--were
to drop sharply, raising the price of imports.
The new economy may be dead, but the mythology that created it survives.
Let's hope that it doesn't cause us any further trouble.
For more information on this topic, see Dean Baker's "The New Economy
Goes Bust" at http://www.cepr.net/new_economy_goes_bust.htm