Do economy and stock market reflect new era?

The most important debate now going on among economists is whether the economy and the stock market reflect a new era or a bubble that likely will burst.

New-era advocates believe that computers and the Internet have fundamentally changed the economy and stock market valuations permanently. Those who support the bubble view are skeptical and think that psychology has far outstripped fundamentals, with potentially disastrous consequences.

Unfortunately, we will not know the truth for some time to come. If the bubble theorists are right, the U.S. economy could eventually tank the way Japan's has.

There, growth also seemed to have risen to a permanently higher plateau, but in the 1990s, Japan's growth stagnated. Its stock market is now down more than 50% from its 1989 high. Bubble theorists think the same thing may happen here.

The problem is that bubbles don't happen for no reason. Throughout history, they have been built on easy money. Thus, Federal Reserve policy is critical to the question of whether the United States is experiencing a bubble or has entered a new era.

So far, the Fed has been extremely skeptical of new-era claims. It has been tightening monetary policy to prevent a bubble from emerging, and Fed Chairman Alan Greenspan has repeatedly warned that the stock market may be overvalued.

Yet, year after year, the economy has continued to grow beyond most forecasters' expectations, and the stock market is now far higher than it 'was when Greenspan first warned about its "irrational exuberance" in 1996. At some point, one just has to accept the fact that something is going on that does not fit the traditional economic models.

Perhaps the strongest critic of the newera model has been Fed Governor Laurence H. Meyer. Before coming to Washington, he was a noted economic forecaster with his own company in St. Louis.

Since joining the Fed, he has consistently warned that the economy was on the brink of an inflationary explosion. He has been especially worried about the steady decline in unemployment, which in the past has preceded rising inflation.

But even this most skeptical of Fed governors has lately been worn down by the failure of low unemployment to trigger any uptick in inflation. In a September 8 speech in Philadelphia, Meyer finally conceded that the trend rate of productivity growth may have risen enough to negate the old relationship between inflation and unemployment.

One factor that may have influenced Meyer's change of heart may be a new study by his old firm, Macroeconomic Advisers, showing that potential productivity growth has risen from 0.3% in 1994 to a current level of 2.9%-almost 10 times higher.

In the past, this company's forecasts have mirrored Meyer's generally pessimistic view of the economy's ability to grow more than 2 to 2r%-w-out triggering inflation. However, if productivity can rise at 2.9% per year, then potential growth in the economy may reach 4% without creating inflationary pressures.

Further evidence for the new-era view is expected shortly from the Commerce Department, which is now revising some key economic statistics.

One major improvement will be to change investments in software from being intermediate goods, whose production does not add to the gross domestic product (GDP), to an investment expenditure that does raise GDP. Raising the measured rate of GDP growth will also raise the rate of productivity growth and national saving.

Private economists are also altering their data to better reflect the impact of rising research and development spending on corporate profits. The effect is to lower price/earnings; ratios, making the stock market less overvalued by historical standards. M

Mr Bartlett a nationally syndicated columnist, is a senior fellow with the National Centerfor Policy Analysis

Copyright Human Events Publishing, Inc. Nov 5, 1999
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