Magazine article Business Review (Federal Reserve Bank of Philadelphia)

Monetary Policy: Stability through Change: Based on a Speech Given by President Santomero to the Philadelphia Estate Planning Council, Philadelphia, November 18, 2003. This Speech Was Adapted from His Remarks at the Third Annual Philadelphia Fed Policy Forum, Which Was Held on November 14, 2003

Magazine article Business Review (Federal Reserve Bank of Philadelphia)

Monetary Policy: Stability through Change: Based on a Speech Given by President Santomero to the Philadelphia Estate Planning Council, Philadelphia, November 18, 2003. This Speech Was Adapted from His Remarks at the Third Annual Philadelphia Fed Policy Forum, Which Was Held on November 14, 2003

Article excerpt

From an economic perspective, I believe 2004 will be a good year. We can expect growth in both GDP and employment to persist, though it will take some time before the economy reaches full potential output. Let me try to explain how we got here and how that path will influence the future direction of our nation's economy.

In my view, this business cycle has been driven by two distinct types of forces: first, a series of extraordinary events that buffeted the economy in rapid succession; and, second, some long-term secular trends that began working their way through the economy, disrupting the flow of activity as they went.

The first category--extraordinary events--includes the bursting of the tech bubble, a substantial stock market correction, a series of corporate scandals and governance issues, the events surrounding September 11, 2001, and, of course, the wars in both Afghanistan and Iraq. These disturbances, while painful, are shorter term and their economic impact continues to fade over time.

The second category, however--the long-term secular trends--brings long-lasting and far-reaching changes to the U.S. economy. They are transforming the way we live and work as a nation. I believe these trends, which include rapidly advancing technology and an increasingly integrated global marketplace, will be the key drivers of our economy in the future.

I will focus here on these long-term trends. However, since both features of our economy must be considered when setting appropriate public policy, I will conclude with some observations on the challenges that both forces of change have presented to monetary and fiscal policymakers.

THE CURRENT STATE OF THE ECONOMY

Let me begin with a little history. The recent business cycle marked a turning point in our economy. We moved from an era of irrational exuberance to a cycle filled with uncertainty and subject to continuous change.

As many people know, the U.S. economy lapsed into recession in March 2001. The recession officially ended in November 2001. But since that time, the overall economy has followed an uncertain, and at times unsteady, road to recovery. GDP growth has been slow and employment growth has proved elusive.

Why has it taken so long for the economy to return to robust growth? Both the recession itself and the protracted recovery have been widely attributed to a confluence of three factors: weak growth in business spending; strong growth in labor productivity; and growing reliance on foreign outsourcing. Yet, in my view, these phenomena are all part of the same story--the story of the unfolding impact of the technological revolution on our economy.

WEAK GROWTH IN BUSINESS SPENDING

First, consider the impact of this revolution on aggregate demand. Fundamentally, the boom--and subsequent bust--of business spending on information and communications technology, or ICT, generated the most recent business cycle.

In retrospect, business technology spending in the late 1990s represented a mix of both good and bad judgments. Some of the ICT spending turned out to be wise and even prescient investment in productive new capital. Some of it was just investment pulled forward for fear that legacy equipment would malfunction in Y2K. And some of it--often combined with ill-conceived "dot com" business plans--reflected overconfidence about the viability of new business models.

In any case, it took the business sector three years, from 2000 through 2002, to digest those investments. From an accounting perspective, it took three years to depreciate the accumulated stock of hardware and software. From an economic perspective, it took three years to put existing capital to its most productive use: reallocating it across firms and fully exploiting its capabilities to boost productivity and cut costs within firms.

But that absorption process seems to have run its course. …

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