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Learning from the Boom: Five Lessons From the 90s

An excerpt from the new book, The Fabulous Decade: Macroeconomic Lessons from the 1990s, by Haas professor Janet Yellen (below) and Princeton professor Alan Blinder on the economic boom of the 1990s.

Straight from two policy-makers who were there, The Fabulous Decade is an insider's view of the key economic policies that shaped most of the 1990s. Their book provides the necessary historical framework for examining this period of unprecedented economic growth and learning from it.

The Fabulous Decade began around 1992 or 1993 under a set of propitious circumstances: the process of restoring fiscal probity was in train thanks to the 1990 budget agreement, monetary policy was pressing firmly on the gas pedal, many American industries had been profoundly restructured, and the economy was growing nicely. Fortunately, US policymakers, led by Bill Clinton and Alan Greenspan, were wise enough to capitalize on this opportunity by continuing the fiscal consolidation and by maintaining extremely loose monetary policy until early 1994. Operating in tandem, this combination of promised fiscal tightening and loose money not only gave GDP a boost but also shifted its composition strongly toward investment.

Once the economy had built up enough forward momentum, the Federal Reserve expertly removed its foot from the accelerator and applied it to the brake - but lightly enough to achieve the proverbial soft landing in 1995. This successful bit of fine-tuning marked a departure from historical norms: most previous episodes of monetary tightening had ushered in recessions. While undoubtedly skillful, the Fed was also lucky that no major shock came along in 1994-95 to spoil its attempted soft landing. Folk wisdom holds that "I'd rather be lucky than good." The Fed was both.

Starting in 1995-96, the US economy was blessed by a series of favorable supply shocks that no one could have anticipated. Foremost among these was the acceleration of productivity - the arrival of the much-heralded New Economy. By conventional definitions, labor productivity stems from two sources: technological advance and capital deepening. Both were in overdrive in the late 1990s. Part of the capital deepening can be attributed to the change in the policy mix - after all, higher investment was the basic goal of the tight budget/easy money mix. But the boom in information technology probably contributed much more to both total factor productivity growth and capital deepening (by lowering the cost of capital). It also undoubtedly helped power the soaring stock market, which rose to heights in 1999-2000 that proved to be unwarranted.

However, the technology spurt was not the only favorable supply shock. The costs of fringe benefits, especially health insurance, decelerated sharply in 1994 and 1995, moderating wage settlements and perhaps shifting the Phillips curve. The dollar soared from 1995 to 1998, driving down import prices. Oil prices declined steadily throughout 1997 and 1998. And, on top of all this good news, data revisions raised the real growth rate and reduced the measured inflation rate, making appearances even better than reality - which was good enough.

Favorable supply shocks like these allow a nation to enjoy some combination of lower inflation and faster real growth. Importantly, the Federal Reserve - whether by design or by accident - took a good deal of the largesse in the form of faster growth and lower unemployment. This it did mainly by forbearance, rather than by easing monetary policy. In fact, the Federal Open Market Committee (FOMC) held the funds rate virtually constant from January 1996 until September 1998.

Many of these positive developments - especially the faster growth and the booming stock market - also contributed to the remarkable turnaround in the federal budget position: from a unified deficit of $164 billion in fiscal 1995 to a surplus of $236 billion by fiscal 2000.

Five Lessons for Policymakers

Perhaps the most obvious lesson from this period is that it is smart to be president of the United States or chairman of the Federal Reserve Board when large, favorable supply shocks come along. But that is not a very useful piece of advice. What other lessons can future policymakers glean from the Fabulous Decade? We would like to call attention, somewhat tentatively, to five.

Main Story / Lesson 1 / Lesson 2 / Lesson 3 / Lesson 4 / Lesson 5

Janet Yellen

Janet Yellen
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