The U.S. economy is now in its 10th year of sustained growth. Moreover, the growth rate has been unusually high and the inflation rate unusually low in the later years of this recovery. And the current recovery, after a brief recession in l990-91, follows the longest prior peacetime recovery. What explains this long boom? Who deserves the credit? And what might end this extraordinary 17-year period of nearly continuous economic growth and declining inflation?
Secretary of the Treasury Lawrence Summers recently observed that “the new economy is based on old virtues.” But those virtues were not recently discovered or created on Clinton’s watch. The origins of the long boom date from a time of troubles in the U.S. economy and government in the late 1970s. At that time, both unemployment and inflation were increasing—a combination of conditions that economists did not understand, so they called it “stagflation.” The federal government couldn’t seem to do anything right, a condition President Carter described as “malaise.” And many business firms were probably never less confident—faced by sluggish productivity, rapidly rising costs, and newly formidable Japanese competition—so they turned to the government for subsidies or protection.
Most recessions are a consequence of monetary policy mistakes or the necessary correction of those mistakes. So a substantial part of the credit for the long boom is due to the long period of unusually effective monetary policy, beginning with the appointment of Paul Volcker as chairman of the Federal Reserve in l979. Volcker implemented a policy of lower money growth, a policy that was interrupted by Carter’s credit controls in the spring of 1980 but reinstated in 1981 with the sustained support of President Reagan; this policy led to the last severe recession in 1982 but reduced the inflation rate by 6 percentage points. Alan Greenspan has maintained this policy since his appointment in 1987, without much support from President Bush but with the sustained support of President Clinton; this led to an unusually steady growth of total demand during the Clinton years through 1998 and a further 2 percentage point reduction in the inflation rate. A sustained policy of tight money has proved both necessary to reduce inflation and, in the long run, consistent with low unemployment.
A second set of policies contributed to the long boom but with a less consistent record—the substantial reduction of domestic economic regulation and the barriers to international trade. With no clear signal from the Carter White House, Congress approved the deregulation of domestic commercial aviation in 1978 and substantially reduced regulation of the railroads, trucks, and banks in 1980. The Reagan administration broadened the deregulatory agenda to include buses, some communications, energy, and ocean shipping, and it narrowed the scope of antitrust enforcement. After a surge of new regulatory legislation during the Bush administration, Congress approved the substantial deregulation of agriculture, banks, and telecommunications during the Clinton administration. Every president during this period endorsed a general reduction in the barriers to international trade. The multilateral Tokyo Round was approved under Carter, free-trade agreements with Israel and Canada under Reagan, NAFTA under Bush, and the Uruguay Round under Clinton. The most inconsistent trade record during this period, interestingly, was under Reagan: a combination of ringing free-trade rhetoric and a massive increase of temporary trade restraints.
Tax policy also contributed to the long boom but was even less consistent. Again, the roots of change date from 1978, with a number of state tax limitation amendments, a reduction of the capital gains tax rate over the opposition of the Carter administration, and approval of the Kemp-Roth plan by the Senate. Reagan won congressional approval of a reduction of the top marginal tax rate from 70 percent to 28 percent and indexing of much of the income tax code. The continued reduction in inflation, moreover, reduced the effective tax rates on those sources of income that are not indexed. The top marginal rate, however, increased to 31 percent under Bush and to 42.5 percent (including the Medicare tax) under Clinton. On net, the federal tax code is better than in 1980, but a revival of the supply-side perspective will be necessary for a more thorough tax reform.
Most important, during this period American scientists and entrepreneurs created and nurtured a third industrial revolution, one based on digital technology and biotechnology. The first personal computer and the first important biotechnology products were both developed in the late 1970s. Moreover, the rapid commercialization of those technologies was based on conditions that are almost unique to the United States. A vigorous venture capital market makes it possible to raise capital on the basis of little more than a good idea. And a flexible labor market makes it possible for small firms to develop and market new products and services. In some cases, there has been an important synergy between the changes in policy and technology. The combination of transportation deregulation and digital technology, for example, has substantially reduced inventories and the vulnerability of the general economy to inventory variation.
Finally, what might bring this long boom to an end? Most likely, as usual, a monetary policy mistake. Unfortunately, the Federal Reserve has already financed an unsustainable increase in total demand starting in the fall of 1998, and the four subsequent increases in the fed funds rate have not yet reduced demand growth to a rate that would avoid an increase in inflation. A least one more rate increase is probable, unless overridden by political concerns. Another poison pill would be measures that would spook investors. A substantial change in liability standards—a possible outcome of the tobacco, gun, and lead paint cases—that would make manufacturers liable for the irresponsible use of their products by consumers would be one such measure. Or a change in antitrust standards, such as a possible outcome of the Microsoft case, that would lead to a court-ordered breakup of a firm based on not much more than its commercial success. Or a change in the reach of U.S. antitrust law, such as has already been tested, that would make the domestic subsidiaries of foreign firms liable for the behavior of their parent company in another country. (We are especially vulnerable to measures that would discriminate against foreign investors, because the United States in now dependent on about $250 billion a year of net foreign investment.)
The primary policy lesson from this record is that the long boom could be sustained indefinitely by the continuation of good policies. Or brought to a crashing end by any number of policy mistakes that are already in the wings.