U.S. Economic Performance: Good Fortune, Bubble, or New Era?

T he performance of the U.S. economy in the late 1990s was very good by most measures. Overall growth was robust; and both the unemployment rate and inflation were at the lowest levels in over 30 years. But for many economists, delight in the economy's strong performance was tempered by puzzlement, even consternation. Since the 1960s, unemployment rates below 6 percent or so had been associated with rising rates of inflation. Yet in the late 1990s, with unemployment rates around 4 percent, inflation declined. Explanations for the breakdown in the historic link between inflation and unemployment tend to fall into two categories: 1 The U.S. economy has been the beneficiary of a number of temporary factors that have held down the inflation rate; and The U.S. economy has entered a new era of intense competition and high productivity growth in which inflation is much less of a threat. In addition, some observers have suggested that the U.S. economy is experiencing an asset price bubble somewhat similar to that in Japan in the late 1980s. 2 While a stock market bubble cannot explain recent low inflation rates, it may help to explain why growth has surpassed most forecasters' expectations. Additionally, one can conceive of circumstances under which a decline in inflation would boost equity prices and possibly create conditions conducive to a bubble. Clearly, these three explanations for our recent good fortune have very different implications for the conduct of monetary policy and for other policies as well. However, as the following will show, determining the true state of affairs is no simple task. The article begins with a very brief overview of the link between unemployment and inflation and then proceeds to discuss some of the arguments surrounding each of the three views of the economy.