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Monetary Policy and the Long Boom

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Monetary Policy and the Long Boom NOVEMBER/DECEMBER1998 John B. Taylor is a professor of economics at Stanford University. The article that follows is a reprint of The Homer Jones Lecture delivered at Southern Illinois University-Edwardsville on April 16, 1998. Kent Koch provided research assistance. this lecture. This month (April 1998) the Monetary Policy United States economy celebrates seven years of economic expansion. By definition and The Long an economic expansion is the period between recessions; that is, a period of con- Boom tinued growth without a recession. The last recession in the United States ended in April 1991, so as of this April we have had seven John B. Taylor years of expansion and we are still going. This current expansion is a record breaker: regret that I never had the opportunity to to be exact it is the second longest peacetime work or study with Homer Jones. But I expansion in American history. Iknow people who worked and studied with But what is more unusual is that this him, and I have enjoyed talking with them and current expansion was preceded by the reading about their recollections of Homer first longest peacetime expansion in Amer- Jones. What is most striking to me, of all that ican history. That expansion began in has been said and written about Homer Jones, November 1982 and continued through is his incessant striving to learn more about August 1990. It lasted seven years and economics and his use of rigorous economic eight months. Although the 1980s expansion research to improve the practical operation of was the first longest peacetime expansion in economic policy. As a college student at American history, the current expansion Rutgers, Milton Friedman studied under may very well continue long enough to Homer Jones. Friedman credits Jones as an become the first longest peacetime expan- essential influence on his own decision to sion. Either way, we are now experiencing study economics, and I want to begin this lec- back-to-back the first and second longest ture with a quote from Friedman (1976, p. peacetime expansions in American history. 436) describing certain features of Homer There is something even more extraordi- Jones character: nary. The recession that occurred between these two record–breaking expansions was— The hallmark of his contribution at least for the economy as a whole—short- is throughout those same traits that lived and relatively mild. Hence, during the exerted so great an influence on me last 15 years not only did we have the two in my teens: complete intellectual longest peacetime expansions in American honesty; insistence on rigor of history, but the sole recession we had during analysis; concern with facts; a drive these 15 years was remarkably short and for practical relevance;and, finally, a mild. This 15-year period of unprecedented perpetual questioning and reexami- stability and virtually uninterrupted growth nation of conventional wisdom. is what I refer to as the The Long Boom. The Long Boom has another character- I am going to return to these character istic which I briefly mention now and traits of Homer Jones later in this lecture discuss in more detail later, for it, too, is a for they are part of the story I want to tell. part of the story I want to tell. The inflation rate has been very low and very stable during The Long Boom, much lower and DEFINING “THE much more stable than during the years LONG BOOM” immediately prior to The Long Boom. I must begin by explaining what I mean Consider this long boom period in by the term “The Long Boom” in the title of comparison with other periods in American FEDERALRESERVEBANKOFST. LOUIS 3 NOVEMBER/DECEMBER1998 Figure 1 States from 1955 to the present. You can see that the economy is growing. You can A More Stable Economy also see the ups and downs: the 1981-82 Percent Billions of 1992 Dollars recession and recovery; and the 1990-91 8000 recession and recovery. The trend line in Tre nd GDP Figure 1 shows where the economy is (right scale) 6000 going in the longer term. The lower part of Figure 1 nicely illustrates the large 4000 4 Real GDP change in economic stability. It’s like a (right scale) 2000 microscope that focuses on the 2 fluctuations in real GDP around trend 0 0 GDP. It shows the GDP gap, which is defined as the percentage difference of real -2 GDP from trend GDP. On the right is Percent GDP Gap where we have been recently. On the left -4 (left scale) is where we were before. You can see -6 clearly in Figure 1 that the ups and 1955 1960 1965 1970 1975 1980 1985 1990 1995 downs— recession, expansion, recession, Since the early 1980s, real GDP has fluctuated much less than in earlier expansion—are much milder and much years—as shown by the movement of the GDP gap. less volatile in the latter period than in the earlier period. During The Long Boom, there is obviously greater stability. This history. First, go back to the 15-year greater stability is one reason why the period before The Long Boom—the late stock market has boomed during the same 1960s and 1970s. In the same span of period, 1982 to the present. time we had four recessions, not one. The economy was much more unstable with many ups and downs. We also had the EXPLAINING THE LONG longest inflation in American history—a BOOM very unstable and high inflation—a What are the underlying reasons for remarkably different experience compared this remarkable and unprecedented period to the last 15 years. The economy was not of economic performance in America? performing well. Many explanations have been offered. For another historical comparison, go Some have to do with inevitable changes back exactly 100 years, to the 1890s. in the structure of the economy that have Compare the 1890s with the 1990s. If the had the fortunate by-product of a more 1990s were like the 1890s, we would have stable economy. Other explanations are had a recession in 1990 or 1991 that was related to economic policy—deliberate bigger, quite a bit bigger, than the one we decisions of economic policymakers to actually had. And that would not have change policy. So which is it? Good been the end of it. We would have had fortune or good economic policy? Let us another recession in 1993, a big one, right consider each in turn. when President Clinton was taking office. In 1996 we would have had yet another Good Fortune? recession. We would have just been Many have noted that the U.S. economy coming out of that recession now. So you is much more service-oriented now than it can see how dramatically different the was in the past. Services—educational ser- economy has been during The Long Boom. vices, legal services, financial services—are Times have changed. generally not as cyclical as manufactured Figure 1 helps visualize this. The goods, such as automobiles or airplanes. upper part of Figure 1 shows real gross Recessions hit manufacturing sectors quite domestic product (GDP) in the United hard. But in the service industries, busi- FEDERALRESERVEBANKOFST. LOUIS 4 N OVEMBER/DECEMBER 1998 ness–cycle fluctuations have been typically Long Boom. There are, of course, two small. So maybe The Long Boom, with its aspects of economic policy one should greater stability, is due to the economy focus on: fiscal policy and monetary policy. becoming more service-oriented. The Let us consider fiscal policy first. problem with this explanation is that the move to a service-oriented economy has been a very gradual change occurring over Fiscal Policy many decades. It could not explain the Has fiscal policy seen a major change sudden shift toward greater economic sta- that could have led to The Long Boom? bility in the early 1980s shown in Figure 1. What about government budget deficits? Hence, a more service-oriented economy is Budget deficits were huge throughout the unlikely to be an explanation. 1980s and much of the 1990s. Budget deficits Others have noted better control of were smaller in the late 1960s and 1970s. inventories. It is true that inventory sales Therefore a smaller budget deficit does not ratios are lower now because inventories seem plausible as an explanation for The are being managed better. The just in time Long Boom. approach to inventory management is now What about the ability of government much more common. During most ups fiscal policy to respond to recessions by and downs in the economy, inventories lowering taxes or increasing spending? fluctuate widely. As the economy starts to Has that response gotten larger, quicker, or dip, firms want to cut their inventories; more efficient? No. In fact, if anything, they reduce their orders, and production the ability of the federal government to falls even more rapidly. Thus, better con- make discretionary fiscal policy changes to trol of inventories may be an explanation mitigate or offset recessions has diminished. for this greater stability that defines The President Bush proposed a small economic Long Boom. But this explanation also has stimulus package to be put in place at the problems. If you take out the fluctuations end of the 1990-91 recession, but Congress of inventories and look at what is left rejected it. In 1993 President Clinton also over—final sales—you see virtually the proposed an economic stimulus package same amount of improvement in economic and again the Congress rejected it. Hence, stability. That is, if I replaced real GDP I have to rule out fiscal policy—either with final sales of goods and services in smaller budget deficits or better counter- the economy in Figure 1, it would look cyclical policy—as a possible explanation essentially the same.
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