TCS Daily


Alan Greenspan's Big Mistake

By James K. Glassman - March 27, 2000 12:00 AM

Alan Greenspan has played a key role in allowing Americans to create the great tech boom of our era. Now he's threatening to destroy that boom. Put simply, the Federal Reserve was dead wrong to raise interest rates last week. There is no evidence - none - that inflation is surging. Thanks to the productivity revolution, fostered by the Internet and networked computing, unit labor costs actually dropped in the second half of last year.

We're in a New Economy, one in which the old rule that growth causes inflation no longer applies. Greenspan helped lay the foundation to the current boom by keeping a dollar a dollar, but now, amid the longest peacetime economic expansion in our history, he's chosen to reverse course - and raise interest rates.

Ironically, Greenspan made the case against rate hikes in his March 6th address at Boston College. Apparently, neither the Fed Chairman nor the press was paying much attention to the first half of his speech. All the coverage focused on the second half, in which he hinted at increased rates and repeated the old theory that growth causes inflation:

"A rise in structural productivity growth, not surprisingly, fosters higher expectations for long-term corporate earnings. These higher expectations, in turn, not only spur business investment but also increase stock prices and the market value of assets held by households, creating additional purchasing power for which no additional goods or services have yet been produced."

The idea is that as people get richer, they seek to buy more things, so you have more people and more dollars chasing the same number of goods. Prices of these goods then rise to meet the increased demand, and voila! - you have price inflation. So according to this theory, the Fed has to raise interest rates to limit growth - and therefore inflation.

What is the counter-argument? Greenspan should know, because only minutes earlier in the very same speech, he eloquently described the positive influence of technology: "Since 1995, output per hour in the nonfinancial corporate sector has increased at an average annual rate of 3-1/2 percent, nearly double the average pace over the preceding quarter-century."

Greenspan correctly attributed these spectacular gains to the power of connected computers, and then described the impact on business:

"At a fundamental level, the essential contribution of information technology is the expansion of knowledge and its obverse, the reduction in uncertainty. Before this quantum jump in information availability, most business decisions were hampered by a fog of uncertainty. Businesses had limited and lagging knowledge of customers' needs and of the location of inventories and materials flowing through complex production systems. In that environment, doubling up on materials and people was essential as a backup to the inevitable misjudgments of the real-time state of play in a company. Decisions were made from information that was hours, days, or even weeks old.

"Of course, large voids of information still persist, and forecasts of future events on which all business decisions ultimately depend will always be prone to error. But information has become vastly more available in real time--resulting, for example, from developments such as electronic data interface between the retail checkout counter and the factory floor or the satellite location of trucks. This surge in the availability of more timely information has enabled business management to remove large swaths of inventory safety stocks and worker redundancies. Stated differently, fewer goods and worker hours are now involved in activities that, although perceived as necessary insurance to sustain valued output, in the end produced nothing of value."

Greenspan should understand the implications of his own analysis: Technology drives productivity growth. Armed with the tools of IT, workers can do more per hour, so even if their wages rise, inflation won't because the workers are delivering more value. And as consumer demand for products increases, prices and inflation will not, because technology allows business to create more products faster and at lower cost. By eliminating redundancies, technology is slashing the cost of producing goods. The tech boom is an inflation-killer! Mr. Greenspan, please let it continue.
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