Are recent Fed actions and monetary targets appropriate for our
technology- and information-based economy?
Technology is everywhere and clearly plays a much more important role
in today's economy than it did just a decade ago. The changing roles of
technology, investment, and productivity in the economy and their effects
on monetary policy pose important questions for Federal Reserve policymakers.
As several of the articles cited below indicate, changes in the economy
are being evaluated and prompting new ways to monitor both the economy
and monetary policy.
First, let's look at just how much of the "new economy" is
real and how much is financial. One place to start is looking
at changes over the past decade in high-tech's share of the economy. FRBSF
Economic Letter 2000-15, titled "Three Questions about 'New Economy'
Stocks," by Simon Kwan, asks just how dominant high technology companies
are in the year 2000 economy. His findings show that high technology firms'
dominance is much greater in terms of stock market valuation than it is
in terms of other standard measures of the economy; total tangible balance
sheet assets, total employment, and total sales by all publicly traded
Kwan notes that as the new economy has expanded, tech firms' market valuation
has soared, from about 7 percent of total stock market capitalization
in 1990, to over one-third in 2000. In contrast, the changes in asset
size, employment, and annual sales of the high tech sector are much smaller.
In 2000, all high tech accounts for less than 10 percent of U.S. assets,
employment, and sales. These three measures show that while high tech
has expanded--its products are being used throughout the economy--high
tech firms have not dominated corporate assets, employment, or sales in
the same way that they dominate equity market valuation. These other measures
indicate that a large "old economy" continues to play an important role
in the U.S. economy.
An even more interesting part of your question, "Is monetary policy appropriate
for the new economy?" also was addressed in Kwan's research. His findings
suggest that monetary policy may affect the new and old economies in different
ways, which is important for policymakers to consider. Kwan concludes:
Technology stocks are not sensitive to interest rate changes after
controlling for systematic stock market movements. With tech stocks
accounting for a large share of the stock market, at sky-high valuations,
any wealth effects stemming from the stock market can be largely attributable
to technology companies. However, can monetary policy be used to bring
down these high fliers? The answer appears to be "no"--not without bringing
down the entire market. This suggests that targeting stock prices may
not be an effective policy approach. Rather, targeting inflation with
an eye on the wealth effect seems to be the better policy to pursue.
Kwan's work is not the only research on the potential relationships between
the new economy and monetary policy. For several years now, Federal Reserve
policymakers have been evaluating how the changing economy and rising
productivity might affect monetary policy. For example, in FRBSF
Economic Letter 99-33, Federal Reserve Bank of San Francisco
President and CEO Robert T. Parry wrote:
The uncertainty about recent productivity growth appears to be the
major uncertainty in the outlook for the U.S. economy, and also for
the conduct of monetary policy.
Soaring investment in high-tech hardware and software in the late 1990s
is considered a key factor in the recent surge in measured productivity.
Accelerating productivity growth has allowed the economy to expand at
a rapid pace without a surge in inflation. FRBSF
Economic Letter 2000-05 by Glenn Rudebusch asks the question,
"How Fast Can the New Economy Grow?" Faster productivity growth already
has increased many economists' estimates of potential supply and of the
ability of the economy to expand at a faster rate without causing inflationary
pressures. This key question was discussed at the Federal Open Market
Committee's (FOMC) February 2000 meeting. The press
release for that FOMC meeting reflected the committee's concerns about
the relationship between productivity, growth, and inflation:
The Committee remains concerned that over time increases in demand
will continue to exceed the growth in potential supply, even after taking
account of the pronounced rise in productivity growth. Such trends could
foster inflationary imbalances that would undermine the economy's record
Another potential issue concerning how high technology relates to monetary
policy was addressed by Bharat Trehan in FRBSF
Economic Letter 99-21 titled, "Supply Shocks and the Conduct
of Monetary Policy." His research suggested use of an alternate economic
indicator to evaluate economic conditions and monetary policy:
The existence of a supply shock makes it hard to judge inflationary
risk by looking at real output growth, since such shocks tend to change
the output-inflation mix in the economy. One response that is robust
to the resulting uncertainty is to pay more attention to the growth
in nominal GDP (or spending). As supply shocks change output and inflation
growth in opposite directions, they will obviously have a smaller impact
on nominal GDP.
Keeping an eye on spending would allow policymakers to keep inflation
within reasonable bounds, even if they were unsure about the economy's
potential growth rate. Using nominal GDP in this way--as an indicator--is
similar to the way that monetary aggregates were employed in the past,
before velocity shifts made them hard to interpret.
Much research has already been done on how the new economy might affect
monetary policy, but further research is needed as the economy and the
financial system adapt to a changing economy.
Board of Governors of the Federal Reserve System. 2000. Press Release
Kwan, Simon. 2000. "Three Questions about 'New Economy' Stocks." FRBSF
Economic Letter 2000-15 (May 12).
Parry, Robert T. 1999. "Risks in the Economic Outlook." FRBSF Economic
Letter 99-33 (October 29).
"Performing miracles." The Economist. June 17, 2000. http://www.economist.com
"Productivity on stilts." The Economist. June 10, 2000. http://www.economist.com
Rudebusch, Glenn D. 2000. "How Fast Can the New Economy Grow?" FRBSF
Economic Letter 2000-05 (February 25).
Trehan, Bharat. 2000. "Supply Shocks and the Conduct of Monetary Policy."
FRBSF Economic Letter 99-21 (July 2).