Soft Thinking About a Soft Landing
The New Economy is full of surprises. Year after year, economists and policymakers are surprised by higher productivity, lower inflation, and faster growth than expected. And lately, just as the Goldilocks economy has appeared to be heating up too dangerously, comes something else unexpected: Growth now appears to be slowing. Just a few weeks ago, economists thought that the Federal Reserve wasn't doing enough to cool things down, but new data show they might be wrong. This turn of events demands a period of watchful waiting for the Fed to see what else unfolds.
What's happened? In the space of two weeks, data from factory orders, housing, consumer credit, retail sales, manufacturing, construction, autos and, most unusually, the big falloff in jobs show a definite slowing of both economic activity and price pressures. Second-quarter growth in real consumer spending is half that of the first. There are even signs of a tech slowdown. True, the sharp jump in unemployment to 4.1% from 3.9% is probably overstated, and the magnitude and durability of the overall slowdown are still wide open to debate (page 41). But there is little doubt that the economy is reaching an inflection point, moving away from the hyper-growth and inflationary surge of recent quarters.
The biggest surprise is in wages. Despite the tightest job market in decades, the latest numbers show that there is hardly any wage inflation. Hourly compensation is one of Fed Chairman Alan Greenspan's favorite indicators because it includes benefits and medical costs. For the first quarter of 2000, hourly compensation for nonfinancial corporations was up by 4.1% compared with a year earlier. That's slower than the 4.9% annual rate for 1999 and the 5.4% rate for 1998. In May, hourly wages were up 3.5% over a year earlier, the same as May a year ago.
Then there's productivity. In nonfinancial corporations, another favorite of Greenspan's, productivity is growing at nearly 4% compared with a year ago, an astonishing feat 10 years into a business expansion. Manufacturing productivity rose 6.9% in the first quarter compared with the same quarter a year ago.
Add up these numbers, and the conclusion is clear: The high-tech New Economy continues to be strongly disinflationary. There is some cyclical inflation, but it is not entrenching itself as it did when it turned up in the '70s and '80s, when there was no New Economy to limit its effects. This time around, inflation is being blunted by secular disinflationary forces that are at work in an information-based society.
Therein lies the policy rub. Cyclical inflation is likely to continue rising over the summer, even as the economy slows. Inflation hawks are protesting that a soft landing that brings growth back down to a sustainable long-term trend of 3% to 4% annually won't be enough to stop the creep of prices. They want the Fed to attempt a soft landing "from below" by tightening rates enough to push growth below its long-term trend and raise the unemployment rate to 5% or more. This is a gamble the Fed should not take: Policy aimed at slowing the economy to 1%-to-2% annual growth and raising unemployment is wildly risky. In the past, soft landings from below rarely avoided a recession. Given recent data on growth, inflation, and productivity, such a risk is unnecessary.