|
|
|
|
Science Technology and the Economic Future edited by Susan Raymond
William J. McDonough
President Federal Reserve Bank of New York
Based on remarks delivered to the New York Academy of Sciences, March 5, 1996.
One of the most important underpinnings of a successful link between technology and economic development is developing and maintaining a long-term, non inflationary economic growth environment. A robust economic environment is essential both for the nation and for the New York region. There are four factors that are critical to that larger goal: a preemptive approach to monetary policy; price stability; deficit reduction; and promoting the economic and financial well-being of weaker segments of society.
Preemptive Monetary Policy
A "preemptive" approach to monetary policy means dealing with inflation before it takes root. One of the most heartening features of the recent period of economic expansion is the continuing good news about inflation. Monetary policy in early 1994 was the tool that firmed up monetary conditions and hence reduced inflationary pressures before they could affect general prices. Why has monetary policy played such a key role in the economy?
First, it is important to appreciate that monetary policy works with uncertain and long time lags. Most of the effect of monetary policy on economic activity takes place over one to two years. But, its effect on prices can be up to three years or longer. Hence, effective monetary policy must anticipate the economy three years in the future in order to have an appropriate effect on inflation.
Second, the inflation experiences of the last two decades indicate that an overheating economy has a much stronger effect on fueling inflation than sub-par growth has on lowering inflation. Once an economy overheats, it is extremely difficult to rein in inflation. This asymmetry—a favorite central banker term—reinforces the need for preemptive monetary policy. Failure to contain inflationary pressures at early stages makes it much tougher to deal with inflation later. If you let inflation grow, the problem gets bigger and bigger and the costs to the American economy to bring prices under control get higher. We are very aware that there are real, live people in that economy who suffer if we fail to act on a timely basis to beat inflation down. Fortunately, the degree to which elected officials, economists, and the general public understand this asymmetry has grown significantly in recent years. So there is broader societal and political support for preemptive monetary policy, which in turn has contributed to its more effective use as a policy instrument.
Price Stability
The primary long-term goal of monetary policy for sustaining economic growth should be price stability. Price stability is achieved when inflation is not considered in household and business decisions. When inflation is under control, businesses and families have confidence in making spending and investment decisions. In turn, those decisions provide the fuel for economic growth.
Hence, I do not believe that there is a conflict between price stability and economic growth. Indeed, sustained economic growth is the means by which you achieve price stability. And only with price stability can the economy expect to achieve the highest possible levels of productivity, real income, employment, and living standards. The economic growth-price stability relationship provides a long-term anchor for monetary policy. Indeed, it is an appropriate measure by which society (and Congress) should hold the Federal Reserve Bank accountable for good or bad results.
A stable economic and financial environment certainly will enhance the capacity of monetary policy to fight occasions of cyclical weakness in the economy. That does not imply that we need (or have) targets for real economic growth. The Fed does not seek to limit growth to two or two and a half percent per year. We have no such targets. In trying to determine the extent of future inflation, we use a variety of economic indicators that reflect demand pressures and supply developments in the economy. These include labor markets, industrial capacity, utilization rates, estimates of the gap between actual and potential gross domestic product, developments in commodity prices and monetary aggregates, the extent of foreign competition, and the like.
Unfortunately, there is no straightforward summary measure that provides a reliable overall assessment of the many complex and diverse influences on inflation. Clearly, the complexity is such that one cannot have absolute growth "targets" with a simple link to monetary decisions.
The Federal Deficit
Even with price stability, economic growth, and monetary policy solidly linked, however, an economic blue sky is not ensured. The U.S. economy faces a very serious structural problem. In sum, we consume far too much and save far too little to sustain a healthy economy over the long term. At the household level, which I believe is the best perspective, we consume over 95 percent of what we earn. We save about 4.5 percent. That rate of savings is simply not enough to fuel the economic investment we need. So, what have we as a nation done? We have imported the savings of other nations to finance our own needs.
To make a bad matter worse, however, the federal budget deficit consumes much of the nation's total household savings.
That, by itself, is not necessarily bad. If we were China with a savings rate close to 30 percent, or Japan at 18 percent, or Chile at 20 percent, then we could afford to finance the deficit and have savings left over for economic growth. But using a large portion of our savings to finance the deficit simply leaves too little left over for productive investment.
We really do not have a formula for raising the American savings rate. How can we induce Americans to save more? Many strategies have been deployed. Few have worked. America's savings behavior appears to be a cultural problem that is poorly understood. That leaves reducing the deficit as the only alternative. It is critical to do not because it is fashionable, but because it is essential for the longer term health of the economy.
Societal Well-Being
It is important to recognize that taking budgetary action will have societal consequences. And policy makers must address these consequences. We may have less public money for many societal needs, but we must not walk away from those needs. We must respond to them. Deep inequities in the social fabric will lead to a poor prognosis for the national economy and for the nation as a whole. No society in the history of the world has prospered with a continuously growing underclass.
It is clear that government alone cannot solve many of the problems we face; lasting solutions require community commitment. Private institutions must become deeply involved in solving local problems.
How does an institution like the Federal Reserve Bank of New York fit into such an equation? The New York Fed actually plays three roles in the Federal Reserve system. We have the major operating responsibility within the U.S. Fed system and help to design and implement monetary policy. Second, we are the international face of the overall Federal Reserve System. Third, we are responsible for the Second Federal Reserve District—this region. Although the national and international roles can be seen as all-consuming,
we have made a renewed commitment to our role in the region. We believe that it is unacceptable that the New York region—our region—is growing its economy at a rate significantly below that of the rest of the nation.
As an institution, therefore, we are increasing our capacity to analyze economic trends in the region and deepening our participation as a partner with community leaders who are designing programs to strengthen the economic development of the region. The November 1995 conference in partnership with the New York Academy of Sciences 1 was an expression of this institutional commitment. The New York Fed is also working with educators to develop courses on banking and is reaching out to high school and college students to improve their understanding of the role of banks in the economy.
In addition, Fed staff members, as individuals, are deeply involved as volunteers in the region as mentors, providing assistance to both students and adults on various banking and economics issues. The staff has worked with the community leaders to determine the needs, and then has stepped in to help.
Note 1: In November 1995, the Federal Reserve Bank of New York and the New York Academy of Sciences co-sponsored a conference on Technology and Economic Development in the Tri-State Region, in collaboration with the Regional Plan Association, the Port Authority of New York and New Jersey, the Partnership of the city of New York, and the U S Department of Labors Bureau of Labor Statistics for the New York Region. The proceedings of 'the conference were published as volume 787 in the Annals of the New York Academy of Sciences under the title The Technology Link to Economic Development: Past Lessons and Future Imperatives. Back.
Email this citation