Wise Words

The annual meeting of the nation's economists isn't exactly a swinging affair. There's lots of talk about asset pricing models, and the hotel hallways resonate with arguments about the right way to specify vector autoregressions (don't ask).

But at the meeting that wrapped up last month in San Diego, Alan Greenspan, our eminent chairman of the Federal Reserve, dropped a bit of a bomb.

During the question-and-answer session, my Economic Policy Institute colleague Max Sawicky, to his immortal credit, inquired as to what Greenspan considered to be the lowest unemployment rate consistent with stable prices. In other words, what's the unemployment rate at full employment?

The chairman stood up, thought for a few moments, and wryly replied, "I've spent many years trying to avoid that question. Thank you very much." Then he sat down.

He got a great laugh, which he deserved. A lesser economist might have blathered on, blowing smoke while equivocating about why such an estimate cannot be made with precision but here are a few guesses anyway.

Now why is this important? It certainly sounds like inside baseball, but the fact is, it has tremendous ramifications far beyond the ballpark.

As we learned in the late 1990s, the best social program for working families is full employment. This is a condition of truly tight labor markets wherein employers must bid wages up to get and keep the workers they need. Note also that such conditions disproportionately benefit those usually left behind in recent economic recoveries, such as minorities and single parents.

When we're not at full employment, we're needlessly sacrificing billions of dollars of growth and millions of hours of productive work. Concretely, if full employment translates into 4 percent unemployment but policy-makers mistakenly think it's 5 percent, we're sacrificing roughly 1.5 million jobs and $55 billion of output per year. That's a big mistake.

So when the world's most important economist evades this crucial question of what is the unemployment rate consistent with full employment, it's worth considering why. Either he doesn't know or he doesn't want to say. I think it's the former, and this has huge implications.

Of course, there are reasons why Greenspan would keep it to himself. Perhaps he doesn't want to tip the markets off as to when he and his team would begin raising interest rates, although they've tried pretty hard lately to send clear signals in this regard.

There are many more reasons, though, to believe that he doesn't know the answer. The best evidence comes from the content of his talk in San Diego. Though Greenspan's language was typically elliptical, he essentially described the life of a successful central banker in this way: "There's a lot coming at you, and you best mine all the data you can for signs as to what it all means … . Rules won't help you."

He spoke of uncertainty and unpredictable outcomes. He mentioned speculative bubbles, wars, and other unexpected but critical developments (like the increase in productivity growth in the second half of the 1990s). He rejected a rule-based approach to monetary policy, and, in this spirit, described the notion of a knowable, stable, full-employment unemployment rate as "suspect at best."

Why is this such a bombshell? Because Greenspan is way ahead of the profession, which still maintains that you can nail down a point estimate of how low unemployment can fall without triggering inflationary pressures. In fact, according to the Congressional Budget Office, it's 5.2 percent.

Never mind the fact that unemployment was just 4 percent in 2000, or that not only did inflation fail to accelerate but, for the first time in decades, wages and incomes rose across the board. The seemingly inexorable rise of inequality, which had served as such a damaging wedge between growth and widespread gains in living standards, slowed as all the bakers got larger slices from the expanding economic pie. For example, the share of all income going to those families in the top 5 percent of the income scale grew from about 15 percent to about 20 percent between 1979 and 1995, but only added another 1 percentage point by 2000. One of the main reasons this happened was that Greenspan ignored the stop signs as the unemployment rate tumbled, and income was more broadly shared.

Nevertheless, these stop signs live on. They had many defenders at our annual meeting. But perhaps Greenspan's quip was telling us that some of our profession's greatest minds should stop wasting their time (and that of their grad students) on this problem. Who knows how low unemployment can fall? To err on the side of caution, as we've done for decades, is devastatingly wasteful. In the face of so much uncertainty, there's no way to tell except to test the waters, as the Fed did in the late 1990s.

The Greenspan legacy may be a rich one, but its greatest gift may prove to be the freedom and creativity to use economic policy in such a way as to ensure that we don't squander growth but, instead, share it.

Jared Bernstein is a senior economist at the Economic Policy Institute in Washington, D.C.

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