8/10/00 1:40 p.m.
A Keynesian Mea Culpa?
Perhaps…but they haven't figured the economy out yet.

By Victor A. Canto of La Jolla Economics

he U.S. unemployment rate is hovering around its 30-year low. To most people (and classical economists) that's cause for rejoicing. Other people (including many non-classical economists), though, worry that if things are going well, it can only mean they're going to get worse.

Keynesians have been scrambling over the past several years to explain how the U.S. has kept growing without a serious inflation threat. Not only have their forecasts been off the mark, but they've been hard pressed to understand the sources of growth and to measure the impact of productivity increases.

It's more than just an academic exercise. Bad forecasts induce bad policy choices. Keynesians argue that errant estimates of productivity gains have been in large part responsible for widespread overestimation of inflation and underestimation of growth. As the recent revision of the National Income and Product Account shows, during the 1990's the real GDP growth rate has been higher than we previously thought while the inflation rate has been lower.

The doomsaying economists who fall into this latter group base their concerns on the supposed Phillips Curve relationship which says that as the unemployment rate declines, wage pressures and production bottlenecks lead to rising production costs that, in turn, lead to rising inflation. Thus, according to the Phillips Curve, the lower unemployment rate is associated with higher inflation and higher real wages. The obvious policy prescription to strong growth — according to Phillips Curvers — is to slow the economy. In effect, they endorse the concept of speed bumps for the economy.

But now they have a new story. In light of their missed forecasts and new evidence from economists in Cambridge, they have paved over the speed bumps. Harvard academics have now agreed with what NRO's economist Larry Kudlow has been saying all along — that recent productivity increases aren't a cyclical phenomenon and that these increases mean higher growth rates can be sustained.

However, the Keynesians now argue that their analysis of productivity gains and the reasons for the stunning performance of the past decade support a case for raising the speed limit of the economy. That is a nice mea culpa by the Phillips Curvers — they now admit that we shouldn't have tried to slow the economy. But they haven't figured it out yet.

It is not the role of monetary policy to set speed bumps on the economy. The role of monetary policy is to provide price stability, while it is the role of fiscal policy to take care of the real side of the economy.