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1999 Annual Report—Federal Reserve Bank of DallasThe New ParadigmA Letter from the PresidentOut on a New-Paradigm Limb"Paradigm" is a pretty fancy word for a country boy. My understanding of it is illustrated by the familiar recipe for boiling a frog. You don't boil a frog by dropping him into boiling water. He'll jump out. Instead, you drop him in cold water and raise the heat. The frog won't jump because he doesn't realize his paradigm is shifting. I believe our economy's paradigm has been shifting. But like the frog, many of us haven't noticed because the change has been gradual. Some attribute its improvement to good luck and temporary factors, or "positive supply shocks" in economists' jargon. We have been lucky, and some of our good fortune has been based on temporary factors. But we at the Dallas Fed believe there's more to it than that—a lot more. We believe once-in-a-century advances in technology are transforming our economy. The computer chip is doing for today's knowledge economy what electricity did for our industrial economy a century ago. Synergies in technology are driving an acceleration in productivity growth that enables us to grow faster with less inflation. Economic progress is speeding up; the speed limit is rising. Technology is the main force driving the New Economy, but not the only one. Deregulation of key industries is a factor. Increased worldwide competition is another. The collapse of communism and hard-core socialism is part of the mix, along with the fall of the Iron Curtain in Europe and the protectionism curtain in Latin America and elsewhere. Freer trade and investment throughout the world are factors. Efficient U.S. capital markets and the unique venture capital system serving high tech are important. So is the switch from budget deficits to surpluses. The Fed has done its part by reducing inflation. In the inflationary environment of the 1970s, squeezed profits could be restored by raising prices, with confidence that competitors would go along. Today's disinflationary environment shifts the burden to productivity-enhancing cost cutting as the main route to higher profits. While many factors are important to the New Economy, our essay focuses on technology. It helps answer the skeptics who find nothing new in the New Economy. I'm on record saying the Internet changes everything. I may exaggerate. "Things are different this time" are infamous last words that put me out on a limb. So be it. The greater exaggeration is to say nothing has changed, except, perhaps, some of the old economy's parameters. We've been growing faster than potential and sustaining the unsustainable for four years and counting. 1999 was another good year for new-paradigm optimists. Real GDP grew over 4 percent. Payroll employment increased by 2.7 million workers, or 2.1 percent. Unemployment fell to 4.1 percent. And core inflation continued to decline, to 2 percent or below, depending on the measure. The year ended with the expansion poised to become America's longest. Real GDP growth has averaged 4 percent for the past four years, with declining inflation. This almost doubles the 2 percent to 2.5 percent not long ago considered the maximum noninflationary potential. But we've been growing faster than potential and sustaining the unsustainable for four years and counting. Sounds odd, doesn't it? Our faster output growth is based primarily on faster productivity growth and secondarily on faster labor force growth. Productivity growth, or increases in output per hour worked, is the main source of rising living standards. It's nice to have more output based on more workers and more hours worked, but more output per hour worked is what raises per capita incomes and living standards. Productivity growth slowed dramatically in the early 1970s, and for two decades thereafter it grew just over 1 percent a year. With the number of hours worked also growing just over 1 percent, the potential noninflationary growth rate—the speed limit—was thought to top out around 2.5 percent. The decline in productivity growth reversed in the 1990s, especially in the second half. Productivity growth now appears to be at least 2.5 percent and rising. An increase from 1 percent to 2.5 percent is an increase of 150 percent, a huge jump with profound implications if sustained. Last year was encouraging. Productivity rose over 3 percent for the year and over 5 percent in the second half. In addition to faster productivity growth, faster labor force growth has also boosted the economy. This was accomplished by drawing down the pool of unemployed labor, as evidenced by the decline in the unemployment rate. I mentioned in last year's Annual Report that it will be difficult to sustain recent growth rates with this shrinking labor pool, and I made two modest suggestions for alleviating the shortage: remove the penalty for Social Security recipients who work, and increase the number of visas for the skilled workers our high-tech sector requires. The need is even greater a year later, making these reforms more urgent. Given today's squeaky-tight labor markets, neither of these proposals should threaten existing workers. The immigration proposal shouldn't be a threat since our colleges are not graduating enough native science and technology students to meet demand. Filling key slots with foreign workers would likely increase the demand for U.S. workers by allowing stalled projects to go forward. In addition, Americans would benefit if U.S. firms could stay put rather than relocate abroad to employ foreign workers. The Federal Reserve Bank of Dallas had a good year in 1999. We—along with our banks—squashed the Y2K bug. We provided more services with improved efficiency. The District's economy remained strong, and our banks remained profitable and well capitalized. A good time—as they say— was had by all. On a personal note, I, too, had a good year. Highlights included my first visit to "Austin City Limits" and to the Grand Ole Opry and the Bluebird Cafe in Nashville. At the Bluebird, the man who wrote one of my favorite songs, "Bubba Hyde," sang it for me. I made pilgrimages to Adam Smith's grave in Scotland, Buddy Holly's in Lubbock and Sam Houston's in Huntsville. 1999 will be a hard year to top.
The New ParadigmThe United States entered the 21st century with its economy on a roll. GDP growth averaged more than 3 percent a year in the 1990s. The country created 17 million jobs, driving unemployment down to a 30-year low of 4.1 percent. Recession receded into memory—only eight months in the previous 17 years.[1] As productivity surged, Wall Street gave the economy rave reviews and the Dow Jones industrial average quadrupled over the decade. Through it all, one feature of the economic
mix remained somewhat surprising. Rather than rising, inflation
fell in the booming 1990s. Consumer prices rose 5 percent
per year at the start of the decade but less than 2 percent
a year from 1996 on. (See PDF for Exhibit
1 Times this good defy traditional economic analysis. For at least the past five decades, conventional wisdom held that a free market economy couldn't long sustain strong growth, a low jobless rate and stable prices. Economists emphasized trade-offs—between unemployment and inflation, between price stability and growth. When the economy started to percolate, the thinking went, surging demand would create supply bottlenecks and rising wages would ignite inflationary pressures. Indeed, economic orthodoxy fixated on a "natural rate" of unemployment—somewhere between 5.5 percent and 6.5 percent—below which the economy couldn't go without escalating inflation. Once the inflationary genie was out of the bottle, the remedy was to brake the economy, which meant fewer new jobs and more layoffs. The dismal science reached another dismal judgment: good times can't last because prosperity sows the seeds of its own demise. To avoid ruinous cycles of boom and bust, the best a mature economy can do is plod along at a growth rate of 2.5 percent a year. Traditional theories are at a loss to explain the 1990s. They miss the mark because of sweeping changes in the U.S. economy. Over the past two decades, a new economy has emerged from a spurt of invention and innovation, led by the microprocessor. These thumbnail-size devices serve as the "brains" for computers and thousands of other products, some as cutting edge as Doppler radar, others as mundane as a musical birthday card. The microprocessor's ability to manipulate, store and move vast amounts of information shifted the economy's center of gravity, creating the era of smaller, faster, smarter, better, cheaper. The microprocessor's myriad spillovers magnify its impact. The microchip ignited wave after wave of invention and innovation. New technologies and new products burst forth, a modern-day alchemy spinning silicon into gold. The microprocessor and its spillovers forged an Information Age infrastructure of ever more powerful and affordable computers, increasingly complex software, data-dense fiber-optic networks, cellular telephones, satellite communications, laser scanners and the ubiquitous Internet. What's different about the New Economy? There's an unbridled dynamism, flowing from an entrepreneurial capitalism. A novel idea and a little money can spark a billion-dollar business almost overnight. Yesterday's economy was dominated by establishment capitalism, with high barriers to entry that disadvantaged newcomers and new products. Economic change occurred at a slower pace. In the New Economy, knowledge is more important to economic success than money or machinery. Modern tools facilitate the application of brainpower, not muscle or machine power, opening all sectors of the economy to productivity gains. The Industrial Age ran on physical plant and equipment. Rapid productivity growth was the province of manufacturing, a shrinking segment of the economy for four decades. Scarcity, the first assumption of the old economy, isn't the dominant feature of the New Economy. Many of today's markets are awash with goods and services. Sellers compete aggressively for buyers. They discount. They cut costs. They expand markets through relentless promotion and advertising. Increasing returns to scale pervade the New Economy. More of today's companies and industries thrive on quantity discounts—the higher the demand, the lower the price. Decreasing returns to scale dominated the old economy, so producing more goods and services pushed prices up. (See Exhibit 2.)
The most far-reaching implication of the New Economy centers on the trade-off between growth and inflation. Now, unemployment can go lower and growth higher without igniting inflation. Policymakers working under yesterday's mind-set had to be vigilant about growth and job creation, reacting quickly to slow the economy before prices spiraled out of control. The New Economy is a controversial concept, still being shaped by debates over its import and implications. That's not surprising, because adjusting to changes in economic fundamentals takes time. The United States has passed through several economic eras. We began as an agricultural society. After the mid-19th century, the steam engine and then electricity transformed the country into an industrial nation. Today, deep into the Information Age, old economic theories fail to explain new realities and policy signposts don't mean what they once did. The challenge lies in adjusting our thinking to the new realities. The Microprocessor MiracleUntil the 1990s, contemporary Americans considered the 1960s the quintessential good times because the United States enjoyed uninterrupted growth for almost nine years.[2] The 1960s, however, don't provide the best corollary for what's happening in today's economy. We need to travel further back in time. From 1895 to 1915, a great burst of inventiveness ushered in an era of rapid technological change and economic growth. Americans saw the arrival of one marvel after another—automobiles, airplanes, telephones, phonographs, radios, elevators, refrigeration and much more. These new inventions barely registered as a blip in a GDP dominated by farming, shopkeeping and small-scale production. In time, though, the industries that grew out of them formed the economic backbone of the 20th century. The advances of this long-ago era would have been impossible without a technology that arrived just after the Civil War: electricity. Thomas Edison, the greatest of American inventors, created the lightbulb in 1879 for the simple task of illuminating a room. To build a market for his invention, Edison harnessed electricity, building the world's first generating plant and distribution network in New York City. As it spread through the economy, electricity recast the economic paradigm. Edison, without intending anything more than turning night into day, triggered a revolution. Without electricity, there would be no spark for internal combustion engines, no power for telephones, radios, refrigerators and air conditioners. Electricity provided an ever-ready energy source for factories, with mass production driving down the cost of making just about everything. Without it, we'd still rely on muscles, steam and wind, rather than electric motors and gasoline engines. We'd still be living in a world of horse-drawn carriages, candles, ice houses and cottage industries. Like electricity, the microprocessor is an important invention in its own right and one that shook the world as it touched off a rapid-fire proliferation of spillovers. The device traces its origins to Dallas, where in 1958 Jack Kilby of Texas Instruments fashioned the first integrated circuit, a bundle of transistors on a piece of silicon. Thus began the grand theme of modern electronics—ever smaller, ever more powerful. Thirteen years later, Ted Hoff of Intel developed the silicon-etching process that produced the first true microprocessors. Initial applications centered on number crunching and rapid data entry. Handheld calculators arrived in 1972, bar code scanners in 1974 and the personal computer in 1975. Over the next decade or so, American industry applied microprocessors to other tasks. Whole new products, progeny of the digital electronic revolution, burst onto the marketplace— cellular telephones, robotic factory hands, air traffic control systems, global positioning satellites, laser surgery tools, camcorders, palm-size personal organizers, to name a few. Microprocessors made existing products better, cheaper and more efficient. Starting in the early 1980s, "smart" features helped fine-tune televisions, cut energy use by refrigerators, control cooking in microwave ovens, memorize program schedules in VCRs and generate diagnostic reports for automobiles. As microprocessors grew in power, computers could handle larger, more complex tasks. The emerging science of computational biology illustrates how computers can spur progress in unexpected areas. New programs allow researchers to quickly decipher genetic code, speeding up development of new drugs and improved plants. Away from the laboratory, new programs open a world of possibilities—from the monsters that inhabit video games to computer-aided design for cars, clothing and houses. Using desktops and laptops, Americans run small businesses, publish newsletters and keep tabs on family finances. A third round of spillovers emerged as computers began to communicate with each other, moving data quickly and inexpensively. Universities were the first to hook computers into networks, but it wasn't long before everyday Americans began to connect via electronic mail. The Internet entered the 1990s as an obscure communications network for educators and scientists. It ended the decade as the library, shopping mall and playground of the masses. The Internet is creating spillovers of its own, making existing industries more efficient and spawning entirely new ones, including web page design and Internet service. The microprocessor miracle, including
its wave of spillovers, wouldn't have been as spectacular
if computing technology hadn't improved at such a rapid clip.
Technical types chart the progress in terms of megahertz.
For the rest of us, it's enough to know that processing power
leapt 7,000-fold in three decades. Number-crunching tasks
that took a week in the early 1970s now require but a minute.
(See PDF for Exhibit 3a Data storage capacity and transmission speeds surged right along with the more powerful microprocessors. A single memory chip now holds 250,000 times as much data as one from the early 1970s—the difference between one page of text and 1,600 books. Transmission speeds increased by a factor of nearly 200,000. Sending the 32-volume Encyclopaedia Britannica on the Internet from New York to San Francisco would have taken 97 minutes in 1970. Today's trunk lines can move the equivalent of eight full sets in just one second. Great leaps of power, capacity and speed
led to even greater reductions in the cost of managing information.
(See PDF for Exhibit 3b As the new technology became better
and cheaper, American businesses and households embraced it.
Only a few thousand homes had a PC in 1980. Now, more than
half of U.S. families own computers, the newest of them 200
times more powerful than IBM's first PC, introduced in 1981.
Two-fifths of households are connected to the Internet, a
mode of instant communication scarcely heard of at the start
of the 1990s. Americans bought $141 billion worth of software
in 1998. (See PDF for Exhibit 4 The Information Age's invention, innovation
and enterprise forged the New Economy. Many of the nation's
high-growth industries wouldn't exist without the microprocessor.
High technology now drives the economy. It accounted for more
than 40 percent of job growth in the 1990s—double the
rate of the 1970s. (See PDF for Exhibit
5 At the end of the '90s, high tech, telecommunications
and health care—the prime beneficiaries of the microprocessor
revolution—made up more than half the market capitalization
of America's 500 largest companies. Three decades ago, high
tech still hadn't come out of the geeks' garages, and manufacturing
and energy accounted for about half the market capitalization.
(See PDF for Exhibit 6 The microprocessor arrived a generation ago, then began revitalizing American industry in the early 1980s. Few understood how much the world was changing until the 1990s, when the Information Age achieved a kind of critical mass. It takes time for an invention to spread through the economy, for spillovers to emerge and for new products to reach the marketplace. Now that it's all coming together, America has new reason to stop seeing itself through a lens of downsizing, inequality and falling living standards. In the 1990s, thanks largely to the microprocessor and its spillovers, America witnessed a resurgence of economic growth, new jobs and productivity. The Cost RevolutionThe payoffs from the microprocessor and its spillovers are part of daily life for just about every American. Yet their mere existence doesn't fully explain the advent of the New Economy, especially the unexpected coupling of lower inflation and faster growth. Today's technologies force us to revise the rules, not only because they spur new industries but also because they embody a sweeping capacity to lower the cost of producing goods and services. Technology impacts prices in several ways. Direct costs fall as Information Age tools make it cheaper to produce goods and services. Other savings come through electronic commerce, which encourages lower prices by expanding markets and increasing competition. Most important, the microprocessor and its spillovers transform the structure of long-term average costs, not just for New Economy enterprises but for the nation as a whole. Direct costs. Corporate America invests heavily in computers, shelling out hundreds of billions of dollars in the 1990s for PCs, servers, software and peripherals. The investment pays off as computers boost the speed, accuracy and efficiency of just about everything businesses do—from the design studio to the factory floor, from the checkout counter to the accounting department. Information systems shorten supply chains, allowing timely delivery and automated reordering that slash inventory and paperwork costs. Direct savings show up in every corner of the economy, reducing pressure for companies to raise prices. Even better, the new technology is often powerful enough to allow many companies to lower prices, a trend most evident in the computer and electronics industries.[3] (See Exhibit 7.)
In 1985, when Ford Motor Co. wanted data on how cars withstood accidents, it spent $60,000 to slam a vehicle into a barrier. Today, Ford's supercomputers can simulate the same collision in 15 minutes for $200. By 2001, the cost of a frontal "crash" in cyberspace will be down to just $10. In the airline business, the Final Approach Spacing Tool, air traffic control software developed for NASA, makes take-offs and landings more efficient. The system has already cut two minutes off the average landing time at Dallas/Fort Worth International Airport. When fully operational nationwide, it will save airlines almost $1 billion a year in jet fuel. Wal-Mart, the nation's largest retailer,
cut up to 20 percent off the cost of operating a delivery
truck by installing computers, global positioning gear and
cell phones in 4,300 vehicles. Supercomputers produce a thousandfold
improvement in seismic data, allowing BP Amoco to find oil
for under $1 a barrel, down from nearly $10 a barrel in 1991.
(See PDF for Exhibit 8 Cutting direct costs means consumers
pay lower prices. At home, too, microprocessors are saving
Americans money. Computer chips are now tucked inside just
about every home appliance—from coffeemakers to garage
door openers. Since 1972, for example, chips have helped reduce
energy consumption by 36 percent for room air conditioners,
42 percent for clothes washers, 50 percent for dishwashers,
61 percent for freezers and 67 percent for refrigerators.
(See PDF for Exhibit 10 Electronic commerce. The past quarter century's inventions and innovations are changing the way Americans buy and sell. Computers, high-speed modems, fiber-optic cables and encryption software came together with the Internet and electronic mail in the 1990s to create e-commerce. Americans are going online to schedule flights, download music, buy books, invest in stocks, purchase cars, find jobs and order groceries for home delivery. The cyberspace marketplace is still in its infancy, amounting to only $151 billion in 1999. By 2003, however, it will rise to an estimated $1.7 trillion, then continue to soar. Consumer purchases get most of the attention, but four-fifths of e-commerce involves business-to-business transactions. Electronic commerce alters the economy's cost structure by intensifying competition. The idea of rivalry among sellers driving down prices has a long pedigree in economics, dating back at least as far as Adam Smith. And there's precedent for technology promoting competition. The canals and railroads of the 18th century and the air transport and interstate highways of the 20th century expanded customer bases and decreased the cost of bringing goods and services to market. The ease of shopping nationally—or even globally—online frees consumers from dependence on local merchants. We can buy wherever products are cheapest, then get delivery overnight. Low-cost outlets win additional business and thrive. High-cost sellers shrink and eventually go out of business. At the same time, electronic commerce reduces or even eliminates layers of retail and wholesale, cutting the cost of marketing and distribution. Today, e-commerce is a worldwide virtual marketplace, open for business 24 hours, seven days a week. (See Exhibit 11.) Internet sites proliferated in the past decade as consumers discovered the convenience of shopping online. At a click of the mouse, they can visit the sites of established retailers—jcpenney.com, walmart.com and homedepot.com. And they have access to hundreds of newcomers, including bookseller amazon.com, lens merchant cheapcontacts.com and sporting goods dealer fogdog.com.
Cyberspace business is a free-for-all, with entrepreneurs striving to meet consumers' needs by devising seemingly endless schemes. Dell Computer lets buyers customize computers online. Internet companies conduct traditional auctions, such as the ones at ebay.com, and so-called reverse auctions, where sellers bid for buyers. Priceline.com and others play a version of "Let's Make a Deal," with customers naming a price for airline tickets, hotel rooms and other items. Sellers then decide whether to accept. Mercata.com brings bulk discounts to the Internet by assembling groups of buyers who want the same products. Ubarter.com matches companies' surplus goods and services in noncash transactions. New applications are making shopping online even easier. Programs scour cyberspace for the best prices—sometimes doing the comparison shopping while the buyer sleeps. Declining long-run average costs. The economics of the Industrial Age centered on the cost structure of yesterday's major industries—manufacturing, mining, agriculture and construction. Their costs may fall as output increases, but not for long. Well before demand is satisfied, enterprises exhaust economies of scale and start bidding up prices for scarce inputs. Production costs for additional units rise, slowly at first but then more rapidly. The bottom line: as Industrial Age companies expanded operations, they had little choice but to raise prices to cover higher costs. In an economy dominated by rising-cost industries, additional demand can ignite inflation. It's this view of basic costs, accurate for an industrial economy, that led analysts to conclude that rapid growth can threaten price stability. The Information Age gave birth to companies
and industries with a decidedly different cost structure.
Their output exhibits increasing returns to scale over a wide
range of products. Instead of rising with additional output,
average costs continue to slope downward. (See
PDF for Exhibit 12 Information Age enterprises need more
customers to recoup their investment in new-product development.
Today, bigger is often better, which helps explain the surge
in mergers and acquisitions in the 1990s. Companies combine
to capture the advantages that come from downward sloping
long-run average cost curves. (See
PDF for Exhibit 13 What frees today's technology from the old model of increasing costs? It's partly changes in the nature of what we produce. Yesterday's goods and services had a "rivalry" in consumption, in which one person's purchase barred anyone else's. In the New Economy, more companies make products—such as information and entertainment— that don't disappear or even degrade with use. They can satisfy many consumers at the same time, so additional demand doesn't lead to shortages. Moreover, many New Economy businesses connect people. It's expensive to link one or two users in a network, but it's far less costly to add customers once the delivery system is big enough to serve a critical mass. This has always been true for telephones, trucking routes, airlines, television and electricity. Now it also applies to the Internet, media and telecommunications, all industries on the economy's leading edge. Finally, the Information Age is largely a world of high fixed and low marginal cost. Modern technology often requires staggering startup costs, with tens or even hundreds of millions of dollars going to design products, recruit workers, purchase equipment and establish a presence in the marketplace. Once in production, however, delivering additional goods or services is typically rather cheap. Consider prescription drugs. It requires
an average $350 million to bring a new pill to market. At
that price, the cost of producing the first dose is exorbitant.
If it takes a penny to produce each additional one, though,
average production costs fall quickly—to $350 each at
1 million pills, $3.51 at 100 million and 4¢ at 10 billion.
(See PDF for Exhibit 14 Many of the new technologies have the
same cost structure. Software companies spend millions on
programmers who write line after line of computer code. Additional
copies are virtually costless if downloaded via the Internet.
In Dallas, the average cost of a minute of cell phone service
falls from nearly 50¢ at 60 minutes per month to just
a dime for 1,000 minutes. (See PDF
for Exhibit 14a The $9 trillion U.S. economy is sprawling and diverse, with millions of companies. Some operate with increasing costs, others with decreasing costs. Fast growth in the New Economy creates more of the latter with each passing year. This alters the cost structure for the nation as a whole, even though a large number of traditional industries continue to exist. Spillovers add to the economy-wide savings.
Computers, software, high-speed data transmission and other
new technologies lower the cost of doing business across wide
swaths of the economy. (See PDF for
Exhibit 15 Give Growth a ChanceThe New Economy isn't a mirage. The microprocessor set off a revolution that spawned a new vitality and challenged old notions about the economy's limits. And there's no end in sight. Industries and applications already in the marketplace will take decades—in some cases, a century or more—to fully mature. More spillovers from the microprocessor, and the innovations those technologies will beget, are just over the horizon. We think of the years straddling 1900 as wonderfully inventive times, personified by Edison, who in bringing electricity to the market launched a revolution. If anything, our times teem with unmatched potential for technological change. Edison gave the world a substitute for physical power. Today's entrepreneurs bring to the fore a more versatile, far-reaching asset—brainpower. Our inventory of science and technology—the raw material of new products and processes—exceeds anything seen before. Global positioning satellites, artificial intelligence and virtual reality are only now emerging as sources of new goods and services. Biotechnology, too, is still in its infancy. Armed with the tools of computational biology, scientists will soon complete the Human Genome Project, an effort to identify our entire genetic code. The research could make possible treatments for a host of conditions—from baldness to Alzheimer's disease. Nanotechnology, the emerging science of molding matter at the molecular level, promises materials that conduct electric pulses with only minute resistance and machines the size of microbes to attack viral diseases. Science gives us new technologies, but entrepreneurs forge new products and organize new industries. From Thomas Edison to Bill Gates, the great architects of enterprise stand as symbols of the legions who turn technology into profits. Capitalism's competition is a race, with the prize going to those who harness technology to deliver newer, better and cheaper products. The new paradigm rises out of a powerful mix—a dynamic market economy percolating with technology. The New Economy manifests America's future, but making the most of it requires new thinking. We can no longer operate under the old assumptions about how fast the economy can grow, how low unemployment can go and when policymakers should apply the brakes to ward off inflation. Judging from the 1990s, the upper limit for noninflationary growth may be a full point or more higher than most economists thought at the start of the decade. Faster growth and low inflation do go together, not just in the short run but in the long term as well. In fact, we've arrived at lower inflation not despite faster growth but because of it. The New Economy needs to expand to capture the benefits of declining long-run average costs. We shouldn't underestimate the microprocessor technology's ability to make us more productive. If industries and workers continue to leap in efficiency, pressure to raise prices won't be as great. By itself, growth is no longer an automatic trigger for inflation. We cannot assume that strong GDP or vigorous demand makes a spike in prices inevitable. As we advance into the New Economy, the best course is to keep the emphasis on direct measures of the price level. After all, the best place to look for inflation is in price statistics, not in readings of economic activity levels. High inflation is undeniably a curse. Rapidly rising prices rob consumers of their hard work and savings. Uncertainty about future costs is unsettling for both individuals and companies. Most important, too-high inflation always leads to a day of reckoning, when the economy must be throttled back to restore stable prices. The worse the inflation, the tighter the screws must be turned. It's right to be vigilant about inflation. Even so, we cannot ignore the changes sweeping the nation and world. The new economic paradigm has brought us the best of all worlds—innovative products, new jobs, high profits, soaring stocks. And low inflation. It's wise to be wary of inflation—but also to give growth a chance. —W. Michael Cox and Richard Alm Notes
Acknowledgments"The New Paradigm" was written by W. Michael Cox and Richard Alm. The essay is based on research conducted by Cox, senior vice president and chief economist, Federal Reserve Bank of Dallas. Sonja Kelly, Meredith Walker, Tom Siems and Charlene Howell provided research assistance. Selected ReferencesAghion, Phillippe, and Peter Howitt, Endogenous Growth Theory (Cambridge: MIT Press, 1998). Carmel, Erran, Jeffrey A. Eisenach and Thomas M. Lenard, The Digital Economy Fact Book (Washington, D.C.: Progress & Freedom Foundation, 1999). DeVol, Ross C., America's High-Tech Economy: Growth, Development and Risks for Metropolitan Areas (Santa Monica, Calif.: Milken Institute, July 13, 1999). Malone, Michael S., The Microprocessor: A Biography (New York: Springer-Verlag New York, 1995). Organization for Economic Cooperation and Development, OECD Science, Technology and Industry Scoreboard 1999: Benchmarking Knowledge-Based Economies (Paris, 1999). Riordan, Michael, and Lillian Hodeson, Crystal Fire: The Birth of the Information Age (New York: W. W. Norton, 1997). Romer, Paul M., "Increasing Returns and Long-Run Growth," Journal of Political Economy, October 1986, pp. 1002–37. Schumpeter, Joseph A., Capitalism, Socialism, and Democracy (New York: Harper & Brothers, 1950); Business Cycles, Vols. 1 and 2 (New York: McGraw-Hill, 1939). U.S. Department of Commerce, Secretariat on Electronic Commerce, The Emerging Digital Economy, April 1998; The Emerging Digital Economy II, June 1999. ———, Bureau of Economic Analysis, Survey of Current Business, "Price Indexes for Selected Semiconductors, 1974–96," February 1998. Exhibit Notes and Data SourcesPage 4 Dow Jones industrial average: FAME Database. Unemployment rate and consumer prices: Bureau of Labor Statistics. Page 8 Microprocessor speed: 1971, 1979 and 1989, Intel Corp. 2000, Chip Geek, www.ugeek.com. DRAM storage: 1973, 1979 and 1988, Hitachi, www.hitachi.co.jp. 2000, Samsung Magazine, December 1998, www.samsung.com/magazine/tech.html. Bandwidth speed: “Is There a Moore’s Law for Bandwidth?” IEEE Communications Magazine, October 1999. Data are for 1970, 1980, 1992 and 1999. Cost of 1 megahertz: 1971, Byte Magazine, www.byte.com. 1979 and 1989, Rhodes University, “25 Years of Microprocessor History,” www.cs.ru.ac.za. 2000, Electronic Buyers’ News Online, www.ebnews.com. Cost of 1 megabit of storage: 1975, 1980 and 1990, “Price Indexes for Selected Semiconductors, 1974–96,” Bureau of Economic Analysis. 1999, Electronic Buyers’ News Online. Average price of 64-Mb DRAM chips as of Dec. 8, 1999. Page 9 Computer programmers, operators and scientists in the United States: 1970, 1980 Census of the Population, Bureau of the Census. 1980, 1990 and 1998, Employment and Earnings, Bureau of Labor Statistics, various years. Latest available data are for 1998. Computer and information sciences degrees: 1971, 1980 and 1990, Statistical Abstract of the United States, 1993. 1996, Digest of Education Statistics, U.S. Department of Education. Latest available data are for 1996. Manufacturers of computers and related devices: County Business Patterns, various years. Latest available data are for 1997. Market value of publicly traded U.S. computer and related devices companies: Compustat. Market values are in 1998 dollars; latest available data are for 1998. Computer-services establishments: County Business Patterns, various years. Latest available data are for 1997. Market value of publicly traded U.S. computer-services companies: Compustat. Market values are in 1998 dollars; latest available data are for 1998. Number of PC software programs: Number of files in CNET’s shareware.com software library as of Dec. 31, 1999, www.shareware.com. Sales of U.S. software companies: 1970 and 1980, Compustat. 1990 and 1998, The Business Software Alliance, Forecasting a Robust Future: An Economic Study of the U.S. Software Industry, June 1999. Data for 1980 and 1998 are annual receipts. Sales are in 1998 dollars; latest available data are for 1998. Market value of publicly traded U.S. software companies: Compustat. Market values are in 1998 dollars; latest available data are for 1998. Households on the Internet: The Digital Economy Fact Book. Worldwide Internet hosts: “Hobbes’ Internet Timeline,” info.isoc.org. A host is a domain name that has an IP address record associated with it. Market value of publicly traded U.S. Internet equipment and services companies: Compustat. Market values are in 1998 dollars; latest available data are for 1998. Worldwide e-commerce revenues: Dataquest Inc. and Forrester Research Inc. Revenues are in 1998 dollars. Worldwide e-mail addresses: eMarketer, www.emarketer.com. Page 10 Page 11 Page 13 Page 14 Page 15 Is Your Refrigerator Running?: Association of Home Appliance Manufacturers, www.aham.org. Clothes washer and dishwasher: Energy use is in kilowatt-hours per cycle. Refrigerator: Energy use is for an automatic defrost, top mount freezer and is in kilowatt-hours per year. Freezer: Energy use is for an upright, automatic defrost and is in kilowatt-hours per year. Room air conditioner: Energy use is based on 750 hours of operation and is in kilowatt-hours per year. Page 19 Page 20 Internet access cost and host density: OECD Communications Outlook (Paris: Organization for Economic Cooperation and Development, 1999), Tables 5.1 and 7.15. Internet access cost is the peak rate of an Internet access basket in 1998, measured in U.S. dollars adjusted for purchasing-power parity. Wireless rates in Dallas: Wireless Week, www.wirelessweek.com. Data are as of March 22, 1999. Page 22 PC sales and prices: Bureau of Labor Statistics; The Wall Street Journal Almanac 1998. 1999 sales are estimated. Chart scale is logarithmic. Cost vs. quantity of wireless calls: Cellular Telecommunications Industry Association, www.wow-com.com. Cost vs. quantity of TV sets: 1978–88, Sears, Roebuck and Co. catalogs. 1992–97, J.C. Penney Company Inc. catalogs. Remaining years are estimates based on linear extrapolation from the two real values surrounding these estimates. Cost vs. quantity of a long-distance call: 1970–87, Statistical Abstract of the United States, various years. 1988–97, Statistics of Communications Common Carriers, Federal Communications Commission. Data for 1982 and 1983 are estimates based on linear extrapolation from the two real values surrounding these estimates. Data are for a five-minute call from New York to Los Angeles. Annual miles flown and cost per mile: Air Transport Association, www.air-transport.org. CreditsPhotos and illustrations
courtesy of Advanced Bionics Corp. (p. 16 upper);
Western Geophysical division of Baker Hughes Inc.
(p. 14 upper); Canon USA Inc., 800-828-4040 (p.
21 upper); Cellemetry LLC, www.cellemetry.com
(p. 14 lower); Cyrano Sciences Inc., www.cyranosciences.com
(p. 21 lower right); About the Dallas FedThe Federal Reserve Bank of Dallas is one of 12 regional Federal Reserve Banks in the United States. Together with the Board of Governors in Washington, D.C., these organizations form the Federal Reserve System and function as the nation's central bank. The System's basic purpose is to provide a flow of money and credit that will foster orderly economic growth and a stable dollar. In addition, Federal Reserve Banks supervise banks and bank holding companies and provide certain financial services to the banking industry, the federal government and the public. Since 1914, the Federal Reserve Bank of Dallas has served the financial institutions in the Eleventh District. The Eleventh District encompasses 350,000 square miles and comprises the state of Texas, northern Louisiana and southern New Mexico. The three branch offices of the Federal Reserve Bank of Dallas are in El Paso, Houston and San Antonio. Federal Reserve Bank of
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