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A St. Louis Fed Perspective on Long-Term
Economic Growth
National Association of Manufacturers Board of Directors Meeting
Loews Ventana Canyon Resort
Tucson, Arizona
April 16, 1999


n the United States today we have in front
of us exciting news on economic growth.
It now appears that the painful period of
unusually slow productivity growth in
the 1970s and 1980s is behind us. The increase
of output per hour of labor input has been high
enough over the last few years that it is increasingly reasonable to believe that the United States
has indeed turned the corner on productivity
growth. This picture is reinforced by the extensive anecdotal reports from all across the country.
But—and this is an important “but”—there is still
considerable uncertainty about this conclusion,
and in any event we have to be very careful to
be realistic about the magnitude of the increase
in productivity growth. My purpose today is to
discuss this issue of productivity growth and
the implications of higher growth for monetary
As with so many other topics in economics,
the place to start is with Adam Smith. More than
200 years ago, in his Wealth of Nations, Smith
explained where economic growth comes from:
The annual produce of the land and labour of
any nation can be increased in its value by no
other means, but by increasing either the number of its productive labourers, or the productive powers of those labourers...The productive
powers of the same number of labourers cannot
be increased, but in consequence either of some
addition and improvement to those machines
and instruments which facilitate and abridge
labour; or of a more proper division and distribution of employment.

Smith was the first to argue with clarity that
a nation’s wealth was in the output of its people,
not the gold in its vaults. And Smith certainly
understood the tremendous importance of productivity growth; he sought to convince his readers
that competitive markets generated wealth and
that many restrictive government policies made
England poorer.
I have an intense interest in growth both as a
citizen and a policymaker. As a citizen, I’d like
to see higher output per worker to enrich the lives
of people everywhere. New technologies are
removing some of the drudgery from our jobs and
making work more interesting. I do not scoff at
material improvements such as the second car,
the vacation home, and so forth, but I do want to
emphasize how important improvement in material well-being has been for vastly greater participation in cultural activities that have historically
been enjoyed by only a small segment of the
In short, I’m going to take for granted, in
today’s remarks, that growth that people want is
a good thing. I’m not going to get bogged down in
philosophical arguments over how much growth
is in fact good for us.
Before I get into these issues, it is important
that I issue a disclaimer. The views I express here
are my own and do not necessarily reflect official
positions of the Federal Reserve System. I’ve had
a lot of help with these remarks from colleagues
in the Research Department of the St. Louis Fed;
they deserve credit for the strengths of my argument. I’ll retain credit for the errors.


The importance of economic growth is easy
to demonstrate. During the 1950s and 1960s, output per hour of labor input grew by about 3 percent
per year. At that rate, output per hour would
double in about 23 years. From 1973 to 1990,
output per hour in the nonfarm business sector
grew at a rate of only 1.04 percent per year. At
that rate, it takes 67 years for output per hour to
double. Currently, it appears that output per hour
is growing at a rate of about 2 percent per year,
which doubles in 35 years. Even a small amount
of extra growth yields astonishing gains for the
United States. With an extra quarter percentage
point of growth, GDP would be about $300 billion
higher after a little more than 10 years. The impact
on the federal deficit alone would be on the order
of $60 billion.
Because the growth in real wages and, therefore, the standard of living, depends on productivity growth, these intervals for productivity to
double at various growth rates translate quite
easily into per capita income. It makes an enormous difference to our society whether income
is doubling every 23 years, or every 67 years.
Individuals, and society as a whole, are much
better off when the median-income family can
enjoy a standard of living that the upper-income
family enjoyed a generation or two earlier.

Since Adam Smith’s day, we’ve filled in some
of the details on how the economy grows, and
amassed a huge amount of empirical information.
We have not, however, improved upon Smith’s
fundamental framework for understanding economic growth. Growth comes from more labor and
capital, improvements in capital, and improvements in the organization of the production
process. As with so many things, Smith had it
right. The only amendment flowing from advances
in economic knowledge this century—and it is an
important amendment—is our greatly increased
understanding of the importance of human capital.

A proposition universally accepted by monetary economists is that monetary policy has relatively little to do with long-term economic growth,
as long as the inflation rate remains modest. I
believe that low inflation is better than not-so-low
inflation, but I am not one who makes the extravagant claim that zero inflation yields enormous
benefits over some modest rate of inflation. Monetary policy can contribute to general economic
stability; and a stable, less cyclical economy
probably raises long-term growth somewhat, and
is in any event desirable for its own sake. Central
banks also make valuable contributions to the
efficiency and safety of the payments system,
which is an essential piece of infrastructure for a
modern economy.
Still, as important as these central bank
responsibilities are, it is clear that the central
government’s activities have far more to do with
growth than anything the central bank does. The
soundness and efficiency of the legal system, the
degree of safety of citizens, tax policy, government
spending and regulation, all affect long-term
economic growth to a vastly greater degree than
central-bank policy.
Long-term economic growth, however, is terribly important to monetary policy in a different
way. Here is the monetary policy issue as I see it.
If we knew how to set the rate of inflation directly,
then we should just choose a zero rate and be done
with it. (My guess is that zero inflation, properly
measured, translates to something like 1 to 11/2
percent annual increase in the consumer price
index as the Bureau of Labor Statistics constructs
that index today.) But the Fed can’t set the rate of
inflation directly; that is not possible in a marketbased economy.
Suppose, though, that the Fed could set the
rate of inflation directly. Interest rates would then
rise and fall as credit demands fluctuated. Fluctuations in interest rates, as with fluctuations in
individual prices and wages, are an inherent
feature of an efficient market economy.
Here, then, is the problem the Fed faces. Given
that the Fed cannot directly control the rate of
inflation, it must focus on some policy instrument
it can control and adjust that instrument as best

A St. Louis Fed Perspective on Long-Term Economic Growth

it can to achieve a low and steady rate of inflation
and a stable economy. The Fed has chosen to focus
on the federal funds rate; at the end of every meeting, the Federal Open Market Committee, the
Fed’s main policymaking body, sets an intended
fed funds rate. To administer the federal funds rate
policy, we must form an opinion on the growth
prospects for the economy. We have no choice.
Why do we have no choice? I may bore you
with a familiar proposition, but we have to get it
on the table to be sure that the rest of these remarks
make sense. Suppose the Fed fixed the federal
funds rate at an unchanging level. If that level
were too low, the inflation rate would start to rise.
As inflation rose, the real rate of interest—the
difference between the (assumed) fixed nominal
federal funds rate and the rate of inflation—would
fall. The lower real rate of interest would add to
borrowing demand and push the inflation rate
even higher. In an effort to hold the interest rate
at the target level, the Fed would create additional
liquidity. Money growth would rise, and then
rise some more. The price level would explode
without limit.
The reverse is also true. If the funds rate is
set too high, the price level would implode, and
the real economy would end up in depression.
Of course, the federal funds rate is not fixed.
But if the Federal Reserve adjusts the intended
federal funds rate too slowly, then the process I
have just sketched works the same way. During
inflation, the real rate of interest falls, increasing
inflationary pressures. During deflation, the real
rate rises, increasing deflationary pressures. The
federal funds rate policy instrument must be
adjusted in timely fashion for monetary policy to
yield a stable economy. This proposition is well
supported by both economic theory and actual
experience. So, put very bluntly, we know that a
federal funds rate fixed for all time, or adjusted
too slowly, is an invitation to disaster.
How does the Fed decide the timing and
degree of fed funds rate adjustments? I will tell
you that there is far less science behind our decisions than I would like. I think I can safely say
that every member of the FOMC would like to feel
more certain about when and how much to adjust

the intended federal funds rate than he or she
does feel. The bottom line is that in the course of
fulfilling our FOMC responsibilities, we have to
judge the probable strength or weakness of the
economy. We want the economy to grow as fast
as its resources and productivity permit, but to
form a view on the appropriate fed funds rate I
have to form a view on the economy’s growth

Many have argued recently that the longrun growth potential of the U.S. economy has
improved. Some even claim revolutionary
improvement. One of the reasons economics is
called the “dismal science” no doubt is economists’ propensity to throw cold water on the more
glamorous and attention-getting theories about
the economy. I feel compelled to do a little of
that sometimes, but today I want to tell you why
I regard myself as a relative optimist about growth.
We must at the outset be clear about the numbers. Optimists and pessimists among serious
students of economic growth are not as far apart
as the popular press would have you believe.
Pessimists believe that the underlying growth of
labor productivity remains bogged down at about
the level of the 1970s and 1980s. That rate is in
the range of 1 to 11/2 percent per year. Optimists
believe that the growth rate of productivity has
risen to the 21/2 to 3 percent range, which translates into average GDP growth in the 3 to 4 percent range over the next few years. Although I am
an optimist on growth, my instincts as a policymaker compel me to concentrate on the midrange
of informed opinion. That to me is the appropriate
basis for policy decisions.

Let me put Adam Smith’s comments about
growth into more modern language: There is broad
agreement among economists that the main factors
that enable an economy to grow are:


• The growth of the quantity of labor input.
• The growth of the quantity of capital input.
• The rate of improvement in the processes
that turn inputs into outputs.
It’s not hard to understand that the total value
of what an economy produces will increase if
the number of people working increases or if
some people acquire valuable skills through education or on-the-job learning. Similarly, providing
workers with more physical capital will increase
their output; a worker can dig a longer ditch in a
day with a backhoe than with a shovel. Economists
have a pretty good handle on these things, both
conceptually and quantitatively.
The mystery lies in that third category,
“improvements in processes.” One might call it
“technological progress” or “innovation,” but that
does little more than rename it. It’s a bit different
than output per hour, which is what people often
mean by productivity. Output-per-hour data combine the effects of investment and technological
I’d like to keep these effects separate today,
because they are really two separate things to
economists. We have no direct way to measure
the contribution of that third category other than
by subtracting the contributions of increased
quantities of labor and capital from output. That
exercise gives us the residual category that economists call “total factor productivity.”
What ends up in that residual category? Well,
it’s a little like art—we know it when we see it.
Total factor productivity soaks up the effects of
everything from rearranging a warehouse so that
popular items are near the loading dock to sweeping changes introduced by innovations like electricity or computers. It shouldn’t surprise us that
it is difficult to measure the contents of the pigeonhole where we dump the effects of fuzzy but profound concepts like “creativity” and “innovation.”
Nevertheless, history offers some lessons about
these things, which I’ll get to shortly.

So where has U.S. growth come from? First
the big picture—the last 50 years. Between 1948

and 1997, output in the private business sector
grew by a factor of five. Increasing quantities of
labor and capital accounted for roughly 60 percent
of that increase, leaving about 40 percent of postwar growth “explained” by growth of this mysterious total factor productivity. The split is roughly
the same for manufacturing.
On the labor side, a couple of important
events need to be factored into our thinking about
the next decade or two. First, of course, was the
baby boom, which greatly increased labor-force
growth. But that source of labor growth is no
longer in the pipeline.
Second, we saw a dramatic increase in women
entering the labor force. Just after World War II,
only 31 percent of women were in the labor force.
That number is now more than 60 percent. A
back-of-the-envelope calculation suggests that
this single factor accounts for about a tenth of
postwar growth. Although women’s labor force
participation rates are still 15 percentage points
below men’s—about 60 percent compared to 75
percent—they have flattened out in the last few
years. Even if the women’s rate does catch up to
the men’s in the long run, we are not looking at the
kind of boost we got from this source during the
last 50 years. Bottom line: we’re unlikely to see a
burst of growth from more people going to work.
Business investment in plant and equipment
has been a bit more important contributor to postwar economic growth than labor inputs. Moreover,
the prospects for investment as a source of growth
appear favorable. In general, I think there is wide
understanding that bad policy—tax policy, financial policy, environmental policy, trade policy—
can profoundly affect a firm’s incentive to invest
in productive assets. Too often in the past, conflicting policy goals have been resolved without
regard for economic efficiency. Although I think
we still have a long way to go in this regard, we
are today more likely to see innovative policies
like tradable pollution permits. This kind of
market-based approach is far less damaging than
the style of regulation that says simply that “thou
shalt not pollute more than 3 parts per billion.”

A St. Louis Fed Perspective on Long-Term Economic Growth

That brings us back to the mystery component—the component that we call total factor
productivity. The fact that this component
accounted for about 40 percent of growth over the
last half century hides one of the most important
and longest-running stories in macroeconomics,
the productivity slowdown that started around
1970. Economists still debate the causes of this
slowdown. Some are convinced that the explanation lies in the energy crises of the 1970s; some
believe that a policy environment unfriendly to
business bears much of the blame. Others point
to the higher inflation rate of the 1970s, and still
others to environmental controls. We have more
theories than data points.
In any case, the growth rate of total factor
productivity did fall by half during the 1970s, and
the decline was even more dramatic for manufacturing than for the economy as a whole.
Has this slowdown ended? At first glance, the
answer appears to be no. Looking at data for the
entire business sector, it appears that the slowdown in the growth rate of total factor productivity has continued. That means that the higher
growth of output per hour of labor input—labor
productivity—in recent years reflects the investment boom—more capital—rather than a higher
growth rate of total factor productivity.
The claim that productivity growth has not
increased doesn’t seem right, though, does it? We
see productivity improvements all around us.
Indeed, in manufacturing it is apparent that most
of the productivity slowdown has evaporated.
There are two ways to interpret this recent
discrepancy between manufacturing and overall
business productivity growth. You might conclude
that manufacturing really has been more innovative—streamlining production processes and so
forth. There is probably some truth to that, but if
it’s the whole story, the rest of the private sector
is doing very badly. My observations suggest that
innovation and improved productivity are all
around us—in manufacturing and elsewhere.
A second angle on these numbers is to think
about whether the measurement of productivity

is distorted. Zvi Griliches, who is one of the leading researchers in this area, argues that the part
of the economy he calls “reasonably measurable”
has declined from about half to less than 30 percent since World War II. The problem is that much
of the economy produces things that are extremely
difficult to measure, and the share of this sector—
services, broadly speaking—keeps growing. Moreover, the productivity slowdown appears to be
persisting in these difficult-to-measure industries.
Griliches’s bottom line is that outside of sectors
like agriculture and manufacturing, where it’s
more or less possible to count things in order to
measure output, we should be extremely suspicious of productivity numbers.

What about the future? We see new electronic
technology all around us. I would guess that most
of you are carrying some of it with you right now.
News stories about the Internet are incessant.
One would surely be justified in suspecting that
all of this represents a productivity revolution of
sorts. And I am partly sympathetic to this view.
In the macroeconomic sphere, though, revolutions take decades. Most people call that evolution.
I believe that information technology will be a
genuine engine of growth for decades, but there
hasn’t been and won’t be a sudden swerve toward
some sort of “new economy.” The history of
“general-purpose technologies,” as economists
call them, tells us why evolution is a better word.
One such general-purpose technology, electricity, has been studied extensively by economic
historian Paul David. According to David, less
than 5 percent of mechanical power in the nation’s
factories was provided by electric motors in 1899.
It took about 20 years for that number to rise to
50 percent. David addressed two interrelated
questions about the spread of electricity use in
general and the use of electric motors in particular.
First, why was the adoption rate so low? Second,
what is special about the spread of a generalpurpose technology like electricity?


Think about what a factory was like before
the electric motor. There was typically a single
source of mechanical energy: a water wheel or,
later, a steam engine. This energy had to be distributed around the plant by mechanical means—
gears, drive shafts, belts and pulleys. Because of
the number of interconnected moving parts, this
system was expensive to build, inflexible and
dangerous. But the initial expense was a sunk
cost, and once in place the system didn’t cost
much to run. So in most cases it didn’t make
sense to scrap an old plant until it physically
wore out, even though the new technology was
markedly superior. Electric motors spread rapidly
in industries that were expanding, but elsewhere
the old technology continued to prevail. There is
a tremendous amount of inertia in this sort of
thing. That is the first lesson about the spread of
technology: It’s simply too expensive for an industrial economy to rearrange its production and
scrap a large part of its capital stock overnight,
no matter how exciting the new technology is.
But the ramifications of the electric motor for
manufacturing, when it was finally adopted, were
immense. Mechanical energy didn’t have to be
distributed from a central source; you just put a
motor where you needed it, so you could easily
reconfigure the production process. The production process could be physically stretched out,
allowing the development of a true assembly line.
New factory structures needed only to keep the
rain off; they no longer needed bracing for heavy,
rapidly moving power-distribution machinery.
Maintenance could be performed on a single
machine, without shutting down the entire factory.
Those of you with a mechanical engineering
background can probably find a hundred more
reasons why the electric motor was such an important invention.
All of these advantages were clear in principle
at the turn of the century, but each business had
to figure out how to adapt the technology to its
needs (as well as needing to amortize older
investments). Thus, though the impact of electricity on manufacturing and daily life was profound,
it was spread over many years.

A more recent example illustrates a slightly
different theme. When the laser was invented in
1957, no one recognized it as a general-purpose
technology. Indeed, Bell Labs didn’t even patent
its invention. For some years, the laser was
regarded as an extremely specialized tool. In fact,
it was biding its time, waiting for complementary
developments in the semiconductor industry.
When inexpensive semiconductor lasers became
available, the laser became ubiquitous. Though
we tend to connect the laser with gee-whiz inventions and weapons, probably its most profound
effect on the U.S. economy is the humble bar-code
reader, which was not practical before cheap
lasers. I don’t have to explain to this audience
how this innovation has altered the economic
landscape in retail stores, libraries, the post office,
even Red Cross blood collection. Virtually anywhere we need to keep track of the movement of
physical objects, you’ll see bar codes of one sort
or another.
Of course, cheaper and cheaper computing
power enables wider spread of bar-code scanners,
just as bar-code scanners allow businesses to
bring computing power to bear on inventory
control, marketing and sales. Who’d have imagined that their combined power would be most
visible in the grocery checkout lane? That’s the
second big lesson about technological change
that I take from economic history: It’s hard to
predict the biggest effects until you’re right in
the middle of them.
Today, we are in the middle of the adoption
cycle for a remarkable set of technological innovations in microprocessors and communications.
It is difficult to believe that these things will not
spur economic growth. But let’s not kid ourselves:
We have yet to figure out what to do with all of
this computer power and the Internet, and it’s
not going to happen overnight. In effect, we must
write the economic software for this technology.
That will take a long time, and we won’t understand how it has shaped our economy until it
has already happened. That seems to be the way
these things have always been.

A St. Louis Fed Perspective on Long-Term Economic Growth

I’ll finish by summarizing the argument.
Long-term economic growth is a terribly important subject for the United States, indeed for every
country. The central bank is really a bit player in
the growth process, provided inflation is kept
relatively low. The gains from low inflation are
worth seeking, but we should not overestimate
their importance compared to government tax,
spending and regulatory policies.
The goal of monetary policy, in my view,
should be to keep the rate of inflation low and as
steady as possible. The Federal Reserve should
not have a rigid view about the equilibrium rate
of unemployment or the economy’s growth potential. I want the unemployment rate to be as low,
and the economy’s growth as high, as government
policies, the ingenuity of the business community, and the preferences of workers and their
families will permit.
Nevertheless, the Federal Reserve, in setting
the intended federal funds rate, cannot avoid
making some judgments about the economy’s
growth potential. I’ve shared with you my thinking
about the economy’s current growth potential. I
am sure that the economy will end up doing better or worse than my best estimate today, but I
have given you my best reading on it.
I hold what I think is a balanced, but essentially optimistic, view. When we examine the
data carefully, it is hard for me to believe that the
economy’s long-run growth potential is as high
as the growth rate of real GDP over the last few
years. Some recent growth has come from adding
workers at a pace that is unlikely to continue, and
some of the measured increases in output per
hour of labor input seem likely to be transitory.
On the other hand, the view that nothing has
happened seems contradicted by data and by a
host of anecdotal reports over the last few years.
My best judgment is that the productivity slow-

down of the 1970s and 1980s is over. However,
we have to be realistic about the magnitude of
the improvement. With all of the optimism that
so marks U.S. culture, and with our satisfaction
about the fine performance of the economy in
recent years, we must not allow ourselves to be
lulled into wishful thinking.
I’ll finish with an observation of special relevance to manufacturing. It has always been true,
and is true today, that swings in aggregate demand
have a greater effect on manufacturing than on
the economy as a whole. I know that certain manufacturing industries have suffered from soft
demand since the Asian crisis took hold in the
summer of 1997. Manufacturing will recover in
due time as Asia recovers, and I sincerely hope
that time comes soon. But the aggregate economy
is doing well, and in my assessment of monetary
policy the Fed must always focus on what is
appropriate for the economy as a whole, even
though particular sectors depart from the average.
These may be industrial or geographic sectors;
California, for example, recovered slowly from
the 1990-91 recession.
Clearly, if monetary policy is too expansionary
for too long, we will have an inflation problem.
Policy will then have to turn restrictive, perhaps
sharply so. Some believe that could be the situation today. If policy errs in the other direction, by
being too restrictive, the economy will sag and
manufacturing will suffer disproportionately. The
Fed walks a fine line. Some of manufacturing
and much of agriculture are not sharing fully in
today’s general prosperity. I understand that, and
wish it were otherwise. I am nevertheless convinced that if anything that I do contributes to
destabilizing the general economy, I will not be
doing manufacturing and agriculture a favor. A
stable aggregate environment is in the long-run
interest of all of us.