Low Unemployment Means Inflation? Dallas Fed's Robert McTeer Says No
by Joseph Guinto
Investor's Business Daily
June 21, 2000

If Dallas Federal Reserve President Robert McTeer doesn't think like most economists, it's understandable.

Spending your childhood summers pumping gas from 7 p.m. to 7 a.m., as McTeer did in his father's rural Georgia truck stop, can make a person unconventional.

"Unconventional" would also be a good way to describe the Dallas Fed under McTeer's nine-year tenure.

In addition to being outspoken on free trade and immigration, the bank was prescient in touting the new economy, particularly the impact of increased productivity on economic growth.

With another Fed meeting scheduled next week, Investor's Business Daily's Joseph Guinto asked McTeer for his thoughts on the state of the economy, the power of productivity and the likelihood of a soft landing for the current economic expansion.

IBD: What separates you from most of your colleagues in the Federal Reserve System?

McTeer: There is a difference in our point of view. If it is fairly clear what's going on in the economy—if the numbers are all telling a certain story that we can all read the same way—that difference doesn't really get reflected publicly. The difference only occurs when the numbers become ambiguous. Beginning in June 1999, our different views of the ways the economy works resulted in a public difference.

My colleagues tend to have more faith in things like the NAIRU and the Phillips curve. As far as the Phillips curve is concerned, I'd say it doesn't exist.

(NAIRU—the nonaccelerating inflation rate of unemployment—holds that a certain level of unemployment triggers inflation. The Phillips curve theory holds that when unemployment declines, inflation increases, and vice versa.)

IBD: Does that difference in approach explain why you voted against rate increases in June and August of 1999, when the Fed first started tightening rates to slow the economy?

McTeer: Yes. At the time, it seemed to me, the arguments for tightening were based on how strong the economy was and how low the unemployment rate was. There are a lot of people who think those factors go along with inflation. But since we'd had such good luck with inflation in the years leading up to that, I thought we ought to wait and see some actual inflation in the price statistics, or at least some leading indicators of inflation, like rising commodity prices.

IBD: Why do you believe so strongly in reacting to actual inflation increases rather than setting policy based on other potential indicators of inflation?

McTeer: It's a radical idea, isn't it? Look for inflation in the inflation statistics themselves because they'll tell you whether inflation is headed up or not. I believe that if you don't know what the growth limits of the new economy are, the best policy approach is not to use prosperity as a leading indicator of inflation. I don't think policy should be tightened based only on rapid growth or low unemployment. As far as I'm concerned, unemployment can't be too low.

IBD: But you did not dissent from rate increases starting in November 1999. So do you believe inflation is headed up now?

McTeer: At the time I dissented the first time, the overall CPI (consumer price index) had not risen in the May or June prior to my dissent. That began to change in September 1999. The inflation numbers that month were not all that favorable, and they haven't been all that favorable since. We had another bad month in March 2000. April and May have been OK, though. They are reassuring.

IBD: Even so, with some increased signs of actual inflation in the actual inflation numbers, can you remain optimistic that the economy will continue to expand?

McTeer: I am optimistic. I think the price indexes have been better of late, and employment growth is good.

The economy for the last 4 ½ years—assuming this quarter comes in decently—has been growing on average faster than 4% a year. And for most of that time it's been doing so with less, not more, inflation. The key to that growth has been productivity, and the key to that productivity has been technology.

Then there are a whole host of things that are continuing to make this economy less inflationary. A lot of those things come under the heading of globalization. Some of them are related to the fact that technology itself tends to be disinflationary.

IBD: You just said the magic word "productivity." What power does it have over the economy?

McTeer: We've moved up from productivity growth of just over 1% a year to more than 3% a year. I like to remind people that that's not a 2% increase, but a 200% increase.

This is a 200% increase with compound interest. And the main thing that raises our standard of living is productivity growth.

Here's why. You can break down our real growth into two parts. Any increase in real output can be attributed to either more output per hour worked—that's productivity—or more hours worked—that's an increase in the labor supply.

It's good to have more output because that means more people are working. But that doesn't necessarily raise per capita income much. What really raises per capita income is when everybody on average starts producing more per hour worked. When that's the case, the working population can generate more output without working any longer.

IBD: What kind of productivity growth can we expect?

McTeer: Productivity growth has been rising throughout the '90s, and it's been doing particularly well in the second half of the '90s. I'm optimistic that a 3% average growth in productivity is sustainable. If you put that together with a 1% growth in hours worked, then you have up to 4% in real growth. And the number of hours worked has been growing faster than that. We've been having about 4.5% real growth lately.

I think those numbers are probably sustainable.

IBD: So you believe the expansion will continue. Do you think, then, the Fed is about to engineer a soft landing—slowing the economy without undermining the expansion?

McTeer: I think we are headed for a soft landing.

It's sort of like drinking vodka. You think you're not feeling it, right before you get pretty tipsy. We started drinking our vodka on June 30, and we'd have another sip and another sip. I think in the last few weeks there's no doubt it has begun to have an effect. We've got two months now of small declines in retail sales. We've got flat leading economic indicators. We've got one month of declining private sector employment when the unemployment rate backed up from 3.9% to 4.1%. And housing is showing some signs of slowing. So it is beginning to have an effect.

Reprinted with permission of Investor's Business Daily