The Complexities of Monetary Policy: The Following Is a Speech President Santomero Delivered to the Downtown Economists Club, New York City, on March 26, 2001. as a Former Academic Researcher Who Is Now President of the Federal Reserve Bank of Philadelphia, I've Encountered Several Places Where Macroeconomic Theory Intersects with Real World Economics. (the Third Dimension)
As a long-time research economist, I derive great enjoyment from spending time with fellow economists. Some call us practitioners of the "dismal science," but all of us in this room know better. After all, this is a meeting of the Downtown Economists Club. "Club" certainly has a festive, friendly ring to it, so I'm confident our time together will be anything but dismal.
As you know, I came to the Federal Reserve Bank of Philadelphia after spending many years on the faculty of the Wharton School. So I thought I would spend my time with you today talking about the interplay between my long experience as an academic researcher and my new responsibilities as a central banker.
Since I joined the Fed last summer, I've encountered several conundrums. I suppose you could also call them "points of tension" -- places where macroeconomic theory intersects with real world economics.
Whatever terminology one uses, these conundrums illustrate the challenges that one confronts in analyzing economic conditions, forecasting their likely future course, and using information that is often imperfect to map out appropriate monetary policy.
As it happens, my tenure at the Fed has partly coincided with events that illustrate some of the fundamental issues that I would like to talk about today. Not long ago there was concern about an overheating economy. Then, in little more than the blink of an eye, there was concern about a possible recession. How quickly things change and how suddenly pressure for policy response shifts direction! I once viewed this from the relatively safe haven of the academy. I now view it from the trenches as a policymaker. It's been an interesting time.
Today I'll talk about four conundrums I've come upon in making monetary policy decisions. Let's take them one at a time.
ON THE SUPPLY SIDE
The first we might call the "supply side" conundrum. The key challenge here lies in resolving the fundamental issue of how rapidly the economy can grow on a sustained basis. There has been much discussion about the U.S. economy's long-run capacity for growth in light of the remarkable gains in productivity in the latter half of the 1990s. The strength of the economy over that period, accompanied by a remarkably low inflation rate, was due, in no small measure, to more rapid productivity growth, which stemmed largely from technology investments made during the decade. With the technology sector undergoing substantial change and reevaluation, it might be interesting to examine this relationship as the first area of focus.
Let me begin with what we know: productivity growth has improved because of technology. But this statement is not as useful as it might be, because one does not know exactly what this foretells about the future pace of productivity growth.
Put another way, we don't have the equation that describes how technology affects productivity. Nor do we have the equation that describes how technology evolves. In the end, we do not even have a satisfying measure of the variable we call technology. So when we ask ourselves how fast the economy can grow going forward, we must acknowledge that there is a substantial degree of uncertainty about the answer because of our limited knowledge of the processes underlying future productivity enhancement.
As an economist I can accept this. But as a policymaker, I have to take the next step -- the one that makes me uncomfortable as an economist. That is, in spite of our uncertainties, indeed our ignorance, I have to make some assessment of the rate at which the application of technological innovations raises potential output going forward. Making that "supply side" assessment is essential to laying out the path of long-term, sustainable economic growth that monetary policy aims to match from the demand side.
Well, what is my estimate? I expect annual productivity growth to average 2 to 3 percent for the foreseeable future. …