Implications of the new economy for macroeconomic policy

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Implications of the new economy for
macroeconomic policy

• Gonzalo Camba-MendezGabriel Quirós

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• The views expressed in this document are those
  of the authors and do not necessarily reflect
  those of the European Central Bank

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Implications of the new economyfor monetary
policy

• A. Key Background Issues
• B. The New Economy
• C. The Challenges for Monetary Policy

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A. Key Background Issues

• The Role of Monetary Policy
• Some economic history
• Lessons from history
• Back to the present
• The Transmission Mechanism

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Some economic history Is there an output -
price trade off?

• Philipps Curve, 50, 60
• Instability of the Phillips Curve, 70
  adaptative, rationale, expectations, 70
  (stagflation), 80
• Natural rate of unemployment / NAIRU
• The experience of monetary policies in 70, 80
• The 90 the new economy potential GDP, high
  productivity growth, structural reforms and high
  non-inflationary growth deflation(?)

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Lessons from history

• Dominant consensus among monetary policy makers
  price stability and anti-inflationary credibility
• Institutional central bank independence.
• Deflation a symmetric risk

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Back to the PresentCentral Banks mandates

• ECB
• Art. 105.1 TEU The primary objective of the
  ESCB shall be to maintain price stability.
  Without prejudice to the objective of price
  stability, the ESCB shall support the general
  economic policies in the Community within a view
  to contributing to the achievement of the
  objectives of the Community as laid down in
  Article 2.
• Article 2 sustainable growth non-inflationary,
  high level of employment and social protection
• (from the 1990s)

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Central Banks mandates

• Federal Reserve Act
• The Board of Governors of the Federal Reserve
  System and the Federal Open Market Committee
  shall maintain long run growth of the monetary
  and credit aggregates commensurate with the
  countrys long run potential to increase
  production, so as to promote effectively the
  goals of maximum employment, stable prices and
  moderate long-term interest rates.
• (from the aftermath of World War II)

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The transmission mechanismTransmission Channels
?R

• Inflation expectations if ne less future
  inflation
• directly on prices
• nominal salaries
• Monetary and financial conditions ITC highly
  used in Financial Sector enhanced efficiency
• liquidity restrictions
• credit supply
• e-banking
• Structure of R, price of financial assets
• cost of capital volatility, technological
  stocks bubble
• substitution effect
• income effect lower nominal rates
• wealth effect bubble, demand shocks
• Exchange rate M, X quick pass-through, but
  subdued

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B. The New Economy

• Some definitions
• The facts US versus euro-area
• A longer perspective Europe catching up?
• Source of differences in ALP

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Some definitions...

• A new economy permanent economy-wide increase
• in productivity growth, as measured by labour
• productivity
• Sources of ? labour productivity
• increase in amount of capital available per hour
  worked capital deepening
• increase in the overall efficiency of the
  economic progress total factor productivity
  (TFP)
• A new economy should reflect a persistent ? TFP

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some definitions

• But an ? TFP is not necessarily the consequence
  of a technological
• change. Also from
• More efficient markets capital, labour
• Enhanced competition globalisation of trade in
  goods and services, e-trade
• Fiscal policy which reduces debt and tax burdens,
  favouring investment and innovation
• Improving regulation of financial markets
• Better managed monetary policy
• ITC allows firms to adapt output to demand
  reduction of inventories (just in time)
  smoother business cycle
• We might better consider a broader concept if
  new economy
• technological innovation, enhanced economic
  environment

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The facts US versus euro-areaAverage labour
productivity (ALP) growth

• per employee
• per hour worked
• significant differences between the two measures
  (relatively intense decline in annual hours
  worked per person in the euro-area in the last 20
  years)
• in period 1982-1995 euro-area ALP p.h.w. growth
  doubled US
• in period 1996-2001 ALP p.h.w. growth in
  euro-area desaccelerated while accelerated in the
  US

Table A Average labour productivity
growth (average annual percentage change)
Basis Period Euro area United States Person
s employed 1982 1989 2.0 1.4 1990 1995
1.7 1.2 1996 2001 1.1 1.7 Hours worked
1982 1989 2.6 1.2 1990 1995 2.3
1.2 1996 2001 1.7 2.0
Source ECB
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A longer perspective Europe catching up (?)

• Ratio between productivity levels in euro-area
  and those in US convergence (1981-1995) and
  certain reversal (1996-2001)
• Relative levels of productivity euro area versus
  the United States1)

ratio in terms of GDP per hour worked ratio in
terms of GDP per person employed
1.00 0.95 0.90 0.85 0.80 0.75
1.00 0.95 0.90 0.85 0.80 0.75
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
1) Euro-area level as a percentage of the US
level, in 1996 purchasing power parities Source
ECB calculations based on national accounts and
OECD data
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Source of differences in ALP...

• Where does the difference in ALP between the US
  and the
• euro-area come from?
• capital deepening (?) (investment in ICT)
• TFP (?) (overall efficiency of the economic
  process)

Table B Contribution to growth in the euro area
and the United States comparison
studies (percentage points)
Country/area Period
Contributions to output growth1) ICT
capital2) TFP growth3) Vijselaar/Albers euro
area 1991 95 0.38 1.25 1996 99 0.73
0.40 Oliner/Sichel4) United States 1991 95
0.57 0.92 1996 99 1.10 1.47 Jorgenson/Sti
roh5) United States 1990 95 0.40
0.73 1995 98 0.75 1.24
Source Vijselaar and Albers (2002) New
Technologies and Productivity Growth in the Euro
Area, ECB Working Paper No. 122
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source of differences in ALPCommon results of
the 3 studies

• TFP growth has been more important for higher
  growth than capital deepening, with one
  significant exception euro-area, 1996-99
• TFP has accelerated its contribution to GDP
  growth in the US in 1996-99 in this period TFPs
  contribution in the US has trippled the
  euro-areas
• ICT capital deepenings contribution has been
  similar in the US and the euro-area in the period
  1996-99

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C. The Challenges for Monetary Policy

• Potential Effects of the New Economy
• Challenges for Policy
• Conclusion and Qualifications
• Concluding remark greater differences in central
  banks emphasis than facts?

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Potential Effects of the New Economy

• Increase in labour productivity ? decrease in
• unit labour cost
• Two basic types of effects
• Output / - costs and prices ? potential GDP
  ? Employment / wages ? Consumption
• or/and
• ? mark-up, i.e. firms profitability ?
  investment ? GDP
• Therefore - ? NAIRU
• - Higher potential GDP growth

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Challenges for Policy

• Assessing the new economy phenomenon and
  reading the signals
• NAIRU (large unemployment reductions without
  inflation risks?)
• potential GDP growth (higher and compatible with
  low inflation?)
• Smoother Business Cycle (Are recessions an issue
  of the past?)
• Bubbles in Stock Markets (?)
• Effects on the Transmission
• High use of ITC in Financial sector enhances the
  efficiency of this sector
• Changes in wealth effects from a new environment
  of high volatility in asset prices
• Increase uncertainty about quantification of lags
  and elasticities

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Conclusion (?) and qualifications

• Conclusion?
• The overall increase in the efficiency of the
  respective economies explain most of the
  differences between ALP growth in the US and the
  euro-area
• As measured by GDP per hour worked, the euro-area
  was catching up the higher historical labour
  productivity until mid-90s

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and qualifications

• TFP growth includes changes in labour quality
  faster growth of employment and type of newcomers
  matter
• TFP developments in especific sectors ICT
  producer sector
• Spillover effects and externalities related to
  the use of ICT
• ICT production sector larger in the US higher
  direct contribution to GDP
• Adaptation of firms to supply and demand shocks
  (greater market flexibility)
• Labour productivity highly pro-cyclical (not
  adjusted)
• in any case, no such differences on both sides
  of the Atlantic in ICT capital deepening. Greater
  significant differences in market flexibility

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Greater differences in relative central banks
emphasis than facts?

• By the FED
• FED Press Release of 13 August 2002
• The current accommodative stance of monetary
  policy, coupled with still-robust underlying
  growth in productivity, should be sufficient to
  foster an improving business climate over time.
• By the ECB
• ECB Monthly Bulletin July 2002, 8 August 2002,
  Editorial
• Economic activity should be supported by the
  absence of major imbalances within the euro area,
  together with favourable financing conditions and
  the increase in real disposable income resulting
  from the decline in inflation from the
  temporarily high level of the first quarter of
  2002.
• not even once productivity is mentioned...

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greater differences in central banks emphasis
than facts?

• but it is continuously repeated the need for
  strucutral reforms on the last occasion (ECB
  Monthly Bulletin July 2002, Editorial, 8 August
  2002) in these terms
• In the field of strucutral reforms, the Broad
  Economic Policy Guidelines recently adopted by
  the EU Council should be implemented in a
  determined way, thereby contributing
  significantly to expanding trend potential
  growth in the euro-area and to reducing the
  still high level of unemployment.