http://www.commondreams.org/views01/1128-04.htm----------------------------------------------------------------------------
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Published on Wednesday, November 28, 2001
"New Economy" Cycle Ends, But Myth Persists
by Dean Baker and Mark Weisbrot In the folklore of the business press, a
widely held explanation has already congealed for the upswing that led
optimists to proclaim the emergence of a "new economy." The now conventional
wisdom flows as follows: together with Congress, the Clinton Administration
got the ball rolling by balancing the federal budget, and moving it towards
surplus. This caused long-term interest rates to fall, which led to an
investment boom-especially in the high-tech sectors-and stimulated such
interest-sensitive purchases as housing.

All that new investment caused productivity to grow by leaps and bounds.
Since productivity-the amount of goods or services that an hour of labor can
produce-is the basis of economic growth, this raised incomes across the
spectrum. The virtuous circle was completed by the response of the Federal
Reserve: because of the surge in productivity, we are told, the Fed didn't
have to worry about rapid growth leading to accelerating inflation. Thus the
Fed was able to lower short-term rates, and allow for a record-long
expansion, with unemployment falling to a 30-year low of 3.9 percent.

Sounds plausible, doesn't it? And familiar. Now let's look at the numbers.
Over the course of the business cycle, real (inflation-adjusted) interest
rates on mortgages and high-grade corporate bonds fell by only 0.8 percent.
This certainly doesn't look like enough to stimulate an investment or
housing boom, and it wasn't. Housing barely increased at all, as a
percentage of the economy. And if we look at both investment components of
GDP (investment plus net exports), the investment share actually declined
slightly.

Productivity growth did increase, as compared to the business cycle of the
80s. But it was still considerably lower than the growth of the 50s and 60s
business cycles. If we adjust for the increased share of output that was
used up in more rapid depreciation-mostly computers and software-the
productivity growth of the 90s cycle does not even beat the 70s. And wage
growth for a typical worker was a paltry 0.5 percent a year.
So much for the "new economy." Still, it was a long expansion, and a
pleasant memory compared to what we are facing right now. So what was behind
it, if the official story doesn't hold up to the numbers? Most importantly,
there was a consumption boom that was driven by an enormous bubble in the
stock market. Personal savings rates fell to zero as upper-income
households-the ones that hold stocks-saw the value of these assets soar.

The Fed's change in policy allowed the expansion to continue. Prior to 1995,
it would slow the economy when unemployment fell below 6 percent, on the
theory that this was the best we could do. But this drastically important
policy change-even today, we have millions of additional jobs as a
result-could have been made at any time. It was not a result of 1990s
productivity increases, but rather the Fed's belated realization that its
prior theory was wrong.

Understanding the 1990s expansion, and its collapse, is vitally important to
getting us out of the current recession. The evaporation of $8 trillion in
stock market wealth translates into more than $300 billion in reduced
consumption. This means we need a stimulus package more than twice as large
as the one that Senate Democrats are proposing (the House Republican plan
contained hardly any stimulus at all, consisting mostly of tax breaks for
corporations and high-income households).

Diehard policymakers and economists-including many Democrats-still cling to
the notion that fiscal conservatism brought us prosperity. They ache to
resume paying off the entire national debt at the earliest opportunity. Many
others welcome the re-inflation of the stock market bubble-which still
exists, and has lately been growing.

And while the Fed has been doing the right thing by lowering interest rates
since the slowdown began, it could still revert to its old ways before the
recovery is on track. This is especially true if our overvalued
dollar-another largely unnoticed bubble from the 1990s expansion-were to
drop sharply, raising the price of imports.

The new economy may be dead, but the mythology that created it survives.
Let's hope that it doesn't cause us any further trouble.

Dean Baker and Mark Weisbrot are co-directors of the Center for Economic and
Policy Research, in Washington, D.C., and co-authors of Social Security: The
Phony Crisis (University of Chicago Press, 2000).

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