Speech

Economic Growth: Is the Fed Irrelevant? St.LouisRegionalCommerceandGrowthAssociationLeadershipCircle St.Louis,Missouri July15,1998 It is a treat to be with you today—aside thewater.Ididn’tfindaplaceonthewaterwithin from a few occasions when I’ve offered commutingdistance,buttheriversarewonderful; informal remarks, this is my first real there’snoquestionaboutthat.Therearealsolotsof speech since I arrived in St. Louis. Begin- funrestaurantsandwonderfulculturalresources ning my Fed speaking career before an organiza- here.Lastweekforthefirsttimewegotoutinto tion dedicated to economic development sends thecountryside.Wedrovetothewinecountry just the right message. tothewestofthecityandhadaverypleasant ComingheretothisjobattheSt.LouisFed evening. isararethingforamonetaryeconomistwhohas Butaswedrivearound—andI’msureyou beensittingonthesidelineswritingjournalarti- haveexactlythesamereaction,ifyoujustgopokclesandnewspaperop-edpiecesandtalkingto ingaroundwithoutanyparticulardestination— peopleaboutwhattheFedoughttobedoing.Now youdoseesomereallyseriousurbanproblems IhavetosaywhattheFedoughttobedoing, inthisarea.InSt.LouisandEastSt.Louis,there decidewhatthatreallyisandputmymoneyon isalotofwhatlookedtome,drivingby,tobe thetable.TheissuesarethesameasthoseIdealt abandonedindustrialland.I’mnotadevelopment withasanacademic,butit’sadifferentmatterto expertoranurbaneconomist,butyouhavetoask whatcanbedoneabouttheseproblems.St.Louis dealwiththemfrominsidetheFed. isnotaloneinhavingthem,butthereisnoreason whySt.Louiscouldn’tbeoutaheadinfixing them.I’msurethatwouldbethedesireofevery- SOME INITIAL OBSERVATIONS… oneinthisroom. Well,IhaveneverbeenthroughaSt.Louis DoestheFederalReservehavearoleinthis summer.ItisHOThereinthesummertime!No process?Well,mymainmessageisgoingtobe questionaboutthat.EventhoughIgrewupin “no,”butIwanttotalktoyouaboutthatandtell DelawareandhavelivedinBaltimoreand youwhattheFederalReservecancontribute.It’s Washington,allofwhicharealsohotinthe veryimportanttounderstandwhatthefunction summer,IguessIhadforgottenwhatthisclimate ofthecentralbankis,whatitcancontributeand islike.IhavelivedinNewEnglandforalongtime. whatitcannot,tounderstandwheretherespon- ButIwillgetusedtotheweatherhere.Itreally sibilityreallylies. isanexcitingmetropolitanarea. Iwanttodividemycommentsintofourmain Wehavebeenhere,GerieandI,justfour topics.I’mgoingtostartwithalittlegame-playing monthsnow.Wehaveenjoyeddrivingaround, toexploretheeffectsofmuchmoreexpansionary exploring,lookingoutthecarwindowsandseeing monetarypolicyormuchmorerestrictivemonewhatwesee.St.Louishasthesegreatrivers,and tarypolicy.We’llspinoutthisscenariotohelp weactuallylookedtoseeifwecouldfindaplace understandwhatwouldhappeniftheFederal toliveonone.Wecamefromawaterfronthome Reserveweretoattempt,let’ssay,topushinterest onNarragansettBayandwelikedtolookoutover ratesdowntopromotedevelopmentinurban 1

ECONOMICGROWTH areasoranywhereelseforthatmatter.Whatwould Considertheoppositepossibility.Again, betheresultofthatprocess? interestrateshavebeenarounda5.5percentshort- Secondly,whatcanmonetarypolicyreally termrate.SupposetheFedweretosay,“Let’sput do?Third,whatistheFed’sroleinthegrowth ratesupat10.”Wemightaswell.Academicslike process?Lastly,I’llmakesomegeneralcomments toplaysuchgames.Let’shaveareallyniceexperionwheregrowthreallycomesfrom. menthere.Let’sputtherateupto10percent. Let’simaginethattheFederalReservewere What’sgoingtohappen?Thereverseoftheprocess tofollowamuchmoreexpansionarymonetary justdescribedwouldgetunderway.Alotoffirms policy.Forsometimenow,theFedhasbeenhold- andhouseholdsthathadbeenborrowingmoney ingshort-terminterestratesatabout5.5percent, tofinancenewprojectswouldbackoff.There and,justforfun,let’ssupposethattheFedput wouldbeareduceddemandforgoods.Factories interestratesdownto3percentandkeptthem wouldslowdownwithpressurecomingoffthe there.Whatwouldhappen? productmarketsandthelabormarkets.Youwould Well,withthewholestructureofinterestrates starttoseesomesoftnessinpricesandwages, downbyacoupleofpercentagepoints,there and,iftheFederalReservehungontointerest wouldbeanincreaseddemandforborrowing. ratesthatweremuchtoohigh,thisprocesswould Morepeoplewouldwanttobuildhousesoradd continue. totheirhouses.Morepeoplewouldwanttobuy Infact,wegotintosomethingsortoflikethis cars.Morecompanieswouldwanttobuildoffice deflationaryspiralattheverybeginningofthe buildingsandfactoriesandsoforth,and,withthe GreatDepressionin1930,‘31,and‘32.TheFederal increaseddemandforcredit,firmsandhouse- Reserveheldinterestratestoohighfortoolong, holdsbiddingforresourcesinaneconomythat andtheeconomystartedadownwardspiral.We isalreadyfullyemployedwouldstarttobidup endedupwithacompletecollapseofthebanking prices. systemandaterriblemess. Sowewouldbegintoseeincreasesinwages SoiftheFedtriestoputinterestratesvery andpricesand—iftheFedreallystuckwitha3 faroffoftheequilibriumfortheeconomy,weare percentinterestrate—thehighertherateofinfla- goingtoendupwithabigproblem,andthatis tion,thecheaper3percentmoneylooks.Ifthe goingtobeaneconomy-wideproblem.TheFed’s inflationrateisrunningat5percentandyoucan responsibilityistotrytofindthatsweetspot borrowat3,well,obviouslythelenderisthen whereinterestratesleadtobalancedgrowthwith givingyouagiftof2percent,andtheprocess lowinflation. wouldcontinueandeventuallywewouldhave Sowhatcanmonetarypolicydo?Asyouare aninflationaryexplosion.Inthemeantime,there wellaware,theU.S.economyistodayinvery, mightbesomesmall—andIwouldemphasizein verygoodshape.Mycareerasaprofessional today’seconomyforsure—smallboosttooutput, economistreallybeganin1963whenIbecamea becauseoureconomyisfullyemployed.Wehave newlymintedassistantprofessoratTheJohns lotsofjobvacancies.Thoseofyouwhoarerecruit- HopkinsUniversityinBaltimore.Since1963, inglaborknowthatitisdifficultthesedaystofill theeconomyhasneverbeeninbettershapethan youremptypositions,andourfactories—although itistoday.Wehaveaverylowunemployment notflatout—byandlargeareprettyfullyoccupied. rate.Wehavethehighestpercentageofthepop- Sowecan’tgetthatmuchmoreoutputoutof ulationemployedthatwehavehadsinceWorld theU.S.economyintheshortrun.Wewouldjust WarII.Wehaveaverylowinflationrate.We getmoreinflation.Thebottomlineisthatifthe havegood—althoughnotbyhistoricstandards FederalReservestepsontheaccelerator,weare sparkling—growthinrealoutput. goingtogetmoreinflation.Atbest,wemightget TheFed’scontributiontothisprocesshas averyshorttemporaryincreaseinoutputfrom beentokeepinflationlow,tokeeptheeconomy persuadingpeopletoworkovertime,orwhatever. balanced,andthat’swhatyieldedthishappy 2

EconomicGrowth:IstheFedIrrelevant? stateofaffairs.Theeconomyseemstobepretty issound.Asoundpaymentssystemisanecessary stable.Wearenotgoingthroughcyclicalfluctua- basisformucheconomicactivity.Youdon’treally tions.That’swhattheFedcando.Ifwedoourjob realizethatuntilyougotoaneconomywhere well,wehaveanoutcomesuchaswehavetoday. thebankingsystemorthemonetarysystemdoes IcanbragalittlebecauseIhavenothingtodo notwork,suchasinRussiatoday,wherethere withthesuccess.I’vejustarrived.IhopeIcan arebigproblemswiththebankingsystem. indeedbragacoupleofyearsfromnowwhenI Irememberafewyearsagotravelingto havebeenhereforawhile.Weshallsee. Romania.MyyoungestsonmarriedaRomanian Thinkagainaboutsomeoftheseurbanprob- woman,andwewentthereforthewedding.Asall lemsthatwetalkedaboutafewminutesago.Why goodU.S.travelersdo,Itookabunchoftraveler’s isitthatwehavesuchvigorousdevelopmentto checks.Ifoundthatitwasalmostimpossibleto thewestofthecity?Again,justfrommywandercashtheminBucharestatthattime.Wehadto ingaroundtryingtofindstoresandfurnitureand gothroughanenormousrigmaroletocashour placestoexplore,whyisitthatthedevelopment traveler’schecksinordertocoversomeofthe istakingplaceinoutlyingareasandweseeall weddingexpensesthatwehadagreedtopayfor. ofthisapparentlyabandonedlandintheurban Sowhenyoucan’tmaketransactionsonaroutine areas?InEastSt.Louis,acrosstheriver,there’sa basis,itreallydoesinterferewiththeefficiency gloriousviewoftheSt.LouisskylineandtheArch, oftheeconomy. andyetit’sawasteland—orsoitseemedfrommy OneoftheFed’sresponsibilities,then,isto drivingoverthere.Ihopethatisnottoostronga makeitamatterofcoursethatthepaymentssyswaytocharacterizethatareaalongtheriver. temworkswell,andwedoaprettygoodjobof Whythiswasteland?Whyarepeoplelocating that.Wealsohaveresponsibilitiesforsupervising oneplaceratherthananother?Ithastodo,obviandregulatingbanksaspartofthatsameprocess ously,withtherateofreturnoninvestmentand ofmakingthefinancialsystemworkwell. therelativeadvantagesofwhereyouputyour Wheredoeseconomicgrowthcomefrom? capital.TheFederalReserveisnotgoingtoaffect thoserelativeratesofreturninoneplaceover Themostimportantthing,ofcourse,isproducanotherplace.ThatisnotwithintheFed’sarea tivity—theincreaseinoutputperhouroflabor ofresponsibility. input.Thatiswhereourwealthcomesfrom. Touseananalogy,todayinsomepartsof TexasandArkansas,thereisdrought.Some regionshavetoomuchrain,butArkansasand A LITTLE PERSPECTIVE… Texashavedrought.Thecropsareshrivelingup. IntheUnitedStatesoverthelast150yearsor TheFedcanprintmoney,buttheFedcan’t so,productivitygrowth—growthofoutputper printrainandwhatthoseareasneedisnotmore houroflaborinput—hasbeenabout2percent money—theyneedrain.Itisthesamesortof peryear.Thatmeansthatoutputperhourdoubles thingwithdevelopmenthere.Whatweneedis in35years.Since1973orthereabouts,productivnotmoremoney,noteasiercreditoranythinglike itygrowthhasbeenmorelike1percentperyear. that.Whatweneedistoimprovetheattractive- Now,thedifferencebetween2and1doesn’tsound nessoftheseareasthatarenotdoingsowell. likeverymuch,but1percentproductivitygrowth TheFed’sroleinthegrowthprocess—my topicthree—issignificant,butnotoverwhelming. meansthatoutputdoublesin70years.Thereisa Maintainingstableandlowinflationisacontri- bigdifferenceinasocietywhereoutputdoubles butiontoefficiencyoftheeconomy.Maintaining in70yearsversus35years. anefficientpaymentsmechanismisimportant. FromtheendofWorldWarIItotheearly Wetakeforgranted—asweshould—thatchecks 1970s,wehadoutputgrowthperhouroflabor clear,wiretransferswork,andthatthecurrency inputofabout3percent.Insteadof35years,out- 3

ECONOMICGROWTH putdoublesinmorelike23or24years.So,ifwe Theengineofgrowth,then,isnotwhatsomeneedwealthtosolvealotofourproblemsandto bodyelsedoes.It’swhateachofusdoesinour enjoythebenefitsofawealthysociety—andIdon’t ownbusiness.Inthecontextofregionaldevelopjustmeanmaterialgoodsperse,butalotofthe mentandgovernmentpolicies,it’snotwhatthe culturalthingsthatweenjoy—productivitygrowth FederalReservedoes,it’snotwhatthefederal isveryimportant.Wehavebeenlaggingbehind governmentdoes,butit’swhatourcommunities onthisfront,withoutanyquestion. dotomakeitattractiveforpeopletobuildhere Wheredoesproductivitygrowthcomefrom? ratherthansomeplaceelse.Tostarttousesome Weoftenfocusonbigthings,likeassemblylines oftheidlelandinoururbanareasisourresponortheinventionofthesteamengineorthemicro- sibilityandnooneelse’s. chip,andobviouslythoseareimportant.ButI alwaysliketoemphasizethatofmuchlarger importanceistheaccumulationofanenormous A COUPLE OF CLOSING numberoflittlethings.Youcanseethisinyour OBSERVATIONS… ownbusinesses—thereturnsyougetfromthe TheFed’smonetarypolicygetsalotofpress. accumulationoflotsoflittlethings. Fedpolicyisobviouslyabigissue.Everybodyis Forexample,someyearsago,theairlines interestedinwhereinterestratesaregoingtogo installedlightercarpetingintheiraircraftto andtheirimpactontheeconomy.Butthemost reduceweightsotherewouldbelessfuelusage importantcontributionisstillfortheFedtokeep andlargerpayloads.Littlethingslikethat.It inflationlow.That’swhathasproducedanecondoesn’tsoundlikeverymuchjusttoinstalllighter omythatisfarmorestableandhasopportunities carpeting. forgrowthwithouttheconfusionofchanging Irememberatthetimeofthefirstenergycrisis currencyvalues.Lowinflationhasmadeamajor in1973whenthefuelpriceswentupsomuch, contributiontotheU.S.economy.That’swhatthe someoftheairlinesweretakingoutsomeofthe Fedcandeliver,that’swhattheFed’sresponsiairlinemagazinesandputtingtheminevery bilityis.IfweattheFedcancontinuetobesucotherseatpocketinsteadofeveryseatpocketto cessfulontheinflationfront,thenwehavedone saveweight.Attentiontodetaillikethatiswhat ourjobwell. I’mtalkingabout. Secondly,theFed’srolesinthepayments AtourReserveBank,wehavehigh-speed processandthesupervisionofbanksareimporsortingmachinesforourcheckoperations.We tantinhelpingconsumersandbusinessesfuncwerehavingproblemswithchecksjammingand tioneffectively.Wehavearesponsibilitytodo notfeedingthroughproperly.Beforeputtingthe ourjobsefficientlythere,too. checksonthemachine,themachineoperator Sothat’sthebottomline.OurjobattheFed nowputseachboxofchecksonavibratortable istoprinttherightamountofmoneyandifyou thatshakesallthechecksdownsothattheedges walkoutofhererememberingonlyonething, arelinedupandthentheyfeedthroughthesorter justremembertheFedcan’tprintrain. properly.Thisextrastepisasimplething,butit addstoproductivity.Theaccumulationofideas likethat,bitbybit,iswhereproductivitycomes frominthelongrun. 4