NCPA - National Center for Policy Analysis

New Economy? Or Inflationary Bubble?

October 13, 1999

Do the economy and the stock market reflect a new era or a bubble that likely will burst? New era advocates believe computers and the internet have changed the economy and stock market valuations permanently. Those who support the bubble view think psychology has far outstripped fundamentals.

Bubbles are built on easy money. Thus Federal Reserve policy is critical. The Fed has been tightening monetary policy to prevent a bubble, and Fed Chairman Alan Greenspan has repeatedly warned that the stock market may be overvalued.

Fed Governor Laurence H. Meyer has 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 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.

  • In fact, according to a new study by Meyer's old firm, Macroeconomic Advisers, potential productivity growth has risen from 0.3 percent in 1994 to a current level of 2.9 percent -- almost 10 times higher.
  • In the past, this company's forecasts have mirrored Meyer's generally pessimistic view that the economy can't grow more than 2 to 2.5 percent without triggering inflation.
  • However, if productivity can rise at 2.9 percent per year, then potential economic growth may reach 4 percent without creating inflationary pressures.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, October 13, 1999.


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