Remarks before the American Bankers Association
Washington, D.C.
Sept. 18, 2000

Thank you, Hjalma.

It's an honor to be here. Will somebody check to make sure the Chairman has left the building? Just kidding.

Hjalma's and my paths crossed about three times last year on the rubber chicken circuit. On one of those occasions, I had to speak right after him. I'd just as soon follow the banjo picker.

Hjalma asked me to talk briefly about what we at the Dallas Fed call our "new-paradigm economy." Our 1999 annual report has an essay entitled "The New Paradigm." You can find that and a lot of other good stuff on our web site, at www.dallasfed.org.

You may know that my New Economy views led me to dissent last year from the FOMC's first two tightening moves. As a result, Business Week called me the "Lone Star Loner" and USA Today called me the dreaded "D" word: Dove. Lone Star Loner is okay, especially in the Lone Star State, but I fretted about the "dove" thing. It depends on your definition. But I can live with the combination, "the Lonesome Dove." It has a nice ring to it. Poetry over accuracy is in the picker-poet tradition of Texas.

The problem is the press coverage it generates. It's been fair and mostly accurate. But some in the press seem to be playing that schoolyard game: let's you and him fight. And you know who "him" is.

There probably is a little difference between my views on the New Economy and the Chairman's—but very little. And it has more to do with rhetoric than substance. You see, I tend to be somewhat exuberant at times.

Actually, the Chairman articulates New Economy views better than most. He just can't be caught sounding exuberant. I believe he agrees with me on the following:

New technology—mainly information and communications technology—and new processes based on the new technology are driving an investment boom that is raising productivity, increasing growth and reducing unemployment to 30-year lows. He understands, better than anyone, that technology-driven, productivity-enhancing investment is inherently disinflationary, if not deflationary. Also, that many aspects of globalization—or global competition—are also reducing the inflationary potential of rapid growth. Reducing, not eliminating.

Those many aspects of globalization include many factors that are boosting the supply sides of the world's economies and exerting downward pressure on prices. They include:

• The collapse of communism and hard-core socialism.
• The replacement of planned economies with market economies.
• Privatization all over the world.
• Deregulation all over the world.
• Freer trade and freer investment flows.
• The application of new technology all over the world.
• Supply-side tax cuts.
• Transformation of budget deficits into surpluses.
• Central bank success in bringing down inflation.

The Chairman understands these things. But he also understands that while our growth potential has risen, it's not unlimited. While inflation is subdued, it's not dead. While the supply side has accelerated, demand can still grow faster. (I said can.) I'm a little bit country and a little bit rock 'n' roll; the Chairman is more classical, in music and economics. When I talk about the economy, I "Rave On" like Buddy Holly. The Chairman is more circumspect.

I would just hate that—having to be circumspect. I could never be the Chairman because I've spent a lifetime trying to learn to speak clearly and get to the point. I could never master Fedspeak. We call it "Greenspeak" on our web site. The best example of Greenspeak I've seen came a couple of years ago in a cartoon. The pillars of the world economy were crumbling and about to fall. Underneath was a chicken with the Chairman's head—obviously Chicken Little. But instead of saying, "The sky is falling. The sky is falling," this chicken was saying, "The sky is measurably weakened. The sky is measurably weakened."

This is fun, but please allow me to say a few serious words about the Chairman, which would embarrass him if he were here and which will probably get me in trouble if he finds out. So, if it's all right with you, let's just keep it between us.

The surest way to get into central banker heaven is to be really tough on inflation—to be a superhawk. Doves need not apply—even Lonesome Doves. Since tightening monetary policy is almost always unpopular, the usual way central bankers show courage is through their willingness to tighten when necessary. Paul Volcker showed that courage when he broke the back of inflation in the 1979–82 period. Alan Greenspan showed it with our preemptive tightening of policy in 1994, which helped prolong the expansion into the longest on record.

But let me suggest another perspective. I think the Chairman has shown even more skill and more courage by not tightening when much expert opinion said he should have. I refer mainly—but not necessarily exclusively—to the 1996–97 period, when traditional inflation indicators were flashing yellow, if not red. The published FOMC minutes show three dissents toward tightening in 1996 and three in 1997. It's hard to say what would have happened if the Asian crisis hadn't intervened. But as it turned out, the next policy change was not tightening but the three easing moves in the fall of 1998, triggered by financial market strains in the aftermath of the Russian default.

The outside pressure to tighten in that period came from some Fed watchers and policy wonks and from some academics from elite universities that don't have good football teams. Hjalma, I don't think any pressure to tighten came from the Southeastern Conference. Certainly not from a Gator.

Conventional expert opinion favored tightening—or at least thought it prudent—because the economy was growing faster and the unemployment rate was declining below rates that had produced rising inflation in the past. The economy was exceeding its speed limit of 2 to 2.5 percent. The models said inflation was imminent. Those models contain—explicitly or implicitly—Phillips curve relationships, which say that inflation goes up when unemployment goes down and vice versa.

A kissing cousin of the Phillips curve is the concept of NAIRU. Aside from an ugly jacket—NAIRU stands for the non-accelerating inflation rate of unemployment—an ugly acronym. The idea is that when unemployment falls too low—below the NAIRU—inflation accelerates. I can't resist an editorial comment here: As far as I'm concerned, unemployment can't get too low.

Let me take a moment to explain where the low speed limit came from—the 2–2.5 percent growth limit and, by implication, the high NAIRU, an unemployment floor perhaps as high as 6 percent. You can divide output growth into its two sources: productivity growth (output per hour worked) and labor supply growth (the number of hours worked). From the early '70s to the early '90s, productivity, or output per hour, grew just over 1 percent per year. Hours worked also grew a little over 1 percent per year. Add them together and output could grow 2 to 2.5 percent—the noninflationary speed limit.

As I indicated earlier, many thought the NAIRU was as high as 6 percent, meaning unemployment below 6 percent would trigger an acceleration of inflation. When that limit was breached without dire consequence, 5.5 percent became the new NAIRU in some people's minds, then 5 percent, and so on.

You know how this story came out—so far. Beginning late in 1995, productivity growth accelerated, as did output growth—without an acceleration in inflation. We've now had almost five years of GDP growth over 4 percent. The unemployment rate declined to 4 percent. Productivity has at least doubled, to more than 3 percent. Over the past four quarters, productivity growth was 5.2 percent and real GDP growth was 6 percent—a 7 percent rate in the second half of '99 and a 5 percent rate in the first half of 2000.

This fantastic record would not exist had the Chairman tried to enforce the old speed limits, NAIRUs and Phillips curves. While conventional economic wisdom mirrored the models, the economy was marching to a new drummer. The Chairman heard that drummer.

Low unemployment carries its own rewards, but it also has helped in many other ways. Low unemployment aided greatly in making welfare reform a success and in turning our chronic budget deficit into surplus. Low unemployment has helped reduce crime and improve health. Low unemployment and tight labor markets have brought many marginal workers into the world of work for the first time and given them the best kind of training—on-the-job training.

We owe this Goldilocks economy primarily to the surge in productivity we've experienced since 1995. While that productivity is based on new technology, the tight labor markets created much of the incentive to make labor-saving, productivity-enhancing investments. If labor markets hadn't been allowed to tighten as much as they did, who knows what would have happened.

When the economy started surprising everyone with improved performance, the cause was uncertain at first. The Chairman and others talked of a mysterious X factor. The No. 1 suspect—the only thing that made sense of everything going on—was a surge in productivity, or output per hour of work. Only productivity increases could explain how wages could accelerate with little increase in unit labor costs and how output could accelerate with less pressure on prices than usual. But increased productivity had been hard to find in the statistics. You could find it everywhere but in the statistics.

When productivity acceleration finally started showing up in the numbers, skeptics explained it as good luck, which economists call "positive supply shocks." It was thought naive and risky to expect such good luck to continue. It seemed that the better your credentials as an economist or the better your record as a forecaster, or model builder, the more reluctant you were to believe that "something is different this time." There was almost an attitude of, Well, it may be working in practice, but will it work in theory?

Fortunately, Alan Greenspan—who knows his theory and all the rules of thumb and can build models with the best of them….(For heaven's sake, I read recently that he solves complex mathematical problems for relaxation.)

Anyway, fortunately, he too appears to be a student of Yogi Berra and Richard Pryor, and when the models falter, he's willing to look closely at the actual, real-world economy. Yogi is alleged to have said, "You can observe a lot just by watching." Richard said, "Who are you going to believe? Me or your own lying eyes?" The Chairman watched, he observed, and he believed his own eyes.

People still ask—still ask—"Can the economy grow 4 percent or more without an outbreak of inflation?" I don't know. But it's been doing so for almost five years. For almost five years, we've been sustaining the unsustainable. At the Mesquite Rodeo on the edge of Dallas, the buzzer goes off once the rider stays on the bull 8 seconds.

Others ask, "Can productivity—which grew less than 1.5 percent from the early '70s to the early '90s—grow twice that fast?" I don't know. But it's been doing so for a couple of years now. And over the past four quarters, productivity grew 5.2 percent. At this point, there are no signs the acceleration has stopped. I will say that if we create too much slack in the labor market, the incentive for labor-saving investments will diminish, which would reinforce the negative impact on productivity that would result from a significantly slowing economy.

We wouldn't even be asking these questions if Chairman Greenspan and the Greenspan Fed had followed the rules—the conventional wisdom of two decades. We wouldn't be asking these questions if he—an old model builder—had trusted the models.

Let me close by saying, Alan Greenspan has the courage to tighten. Perhaps more important, he has the courage not to tighten. And he has the wisdom to know the difference.

And he's probably going to kill me if he reads this. So, as I said earlier, let's keep it between you and me and the gatepost.

About the Author McTeer is president and CEO of the Federal Reserve Bank of Dallas.