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Economic Growth: Is the Fed Irrelevant?
St. Louis Regional Commerce and Growth Association Leadership Circle
St. Louis, Missouri
July 15, 1998


t is a treat to be with you today—aside
from a few occasions when I’ve offered
informal remarks, this is my first real
speech since I arrived in St. Louis. Beginning my Fed speaking career before an organization dedicated to economic development sends
just the right message.
Coming here to this job at the St. Louis Fed
is a rare thing for a monetary economist who has
been sitting on the sidelines writing journal articles and newspaper op-ed pieces and talking to
people about what the Fed ought to be doing. Now
I have to say what the Fed ought to be doing,
decide what that really is and put my money on
the table. The issues are the same as those I dealt
with as an academic, but it’s a different matter to
deal with them from inside the Fed.

Well, I have never been through a St. Louis
summer. It is HOT here in the summertime! No
question about that. Even though I grew up in
Delaware and have lived in Baltimore and
Washington, all of which are also hot in the
summer, I guess I had forgotten what this climate
is like. I have lived in New England for a long time.
But I will get used to the weather here. It really
is an exciting metropolitan area.
We have been here, Gerie and I, just four
months now. We have enjoyed driving around,
exploring, looking out the car windows and seeing
what we see. St. Louis has these great rivers, and
we actually looked to see if we could find a place
to live on one. We came from a waterfront home
on Narragansett Bay and we liked to look out over

the water. I didn’t find a place on the water within
commuting distance, but the rivers are wonderful;
there’s no question about that. There are also lots of
fun restaurants and wonderful cultural resources
here. Last week for the first time we got out into
the countryside. We drove to the wine country
to the west of the city and had a very pleasant
But as we drive around—and I’m sure you
have exactly the same reaction, if you just go poking around without any particular destination—
you do see some really serious urban problems
in this area. In St. Louis and East St. Louis, there
is a lot of what looked to me, driving by, to be
abandoned industrial land. I’m not a development
expert or an urban economist, but you have to ask
what can be done about these problems. St. Louis
is not alone in having them, but there is no reason
why St. Louis couldn’t be out ahead in fixing
them. I’m sure that would be the desire of everyone in this room.
Does the Federal Reserve have a role in this
process? Well, my main message is going to be
“no,” but I want to talk to you about that and tell
you what the Federal Reserve can contribute. It’s
very important to understand what the function
of the central bank is, what it can contribute and
what it cannot, to understand where the responsibility really lies.
I want to divide my comments into four main
topics. I’m going to start with a little game-playing
to explore the effects of much more expansionary
monetary policy or much more restrictive monetary policy. We’ll spin out this scenario to help
understand what would happen if the Federal
Reserve were to attempt, let’s say, to push interest
rates down to promote development in urban


areas or anywhere else for that matter. What would
be the result of that process?
Secondly, what can monetary policy really
do? Third, what is the Fed’s role in the growth
process? Lastly, I’ll make some general comments
on where growth really comes from.
Let’s imagine that the Federal Reserve were
to follow a much more expansionary monetary
policy. For some time now, the Fed has been holding short-term interest rates at about 5.5 percent,
and, just for fun, let’s suppose that the Fed put
interest rates down to 3 percent and kept them
there. What would happen?
Well, with the whole structure of interest rates
down by a couple of percentage points, there
would be an increased demand for borrowing.
More people would want to build houses or add
to their houses. More people would want to buy
cars. More companies would want to build office
buildings and factories and so forth, and, with the
increased demand for credit, firms and households bidding for resources in an economy that
is already fully employed would start to bid up
So we would begin to see increases in wages
and prices and—if the Fed really stuck with a 3
percent interest rate—the higher the rate of inflation, the cheaper 3 percent money looks. If the
inflation rate is running at 5 percent and you can
borrow at 3, well, obviously the lender is then
giving you a gift of 2 percent, and the process
would continue and eventually we would have
an inflationary explosion. In the meantime, there
might be some small—and I would emphasize in
today’s economy for sure—small boost to output,
because our economy is fully employed. We have
lots of job vacancies. Those of you who are recruiting labor know that it is difficult these days to fill
your empty positions, and our factories—although
not flat out—by and large are pretty fully occupied.
So we can’t get that much more output out of
the U.S. economy in the short run. We would just
get more inflation. The bottom line is that if the
Federal Reserve steps on the accelerator, we are
going to get more inflation. At best, we might get
a very short temporary increase in output from
persuading people to work overtime, or whatever.

Consider the opposite possibility. Again,
interest rates have been around a 5.5 percent shortterm rate. Suppose the Fed were to say, “Let’s put
rates up at 10.” We might as well. Academics like
to play such games. Let’s have a really nice experiment here. Let’s put the rate up to 10 percent.
What’s going to happen? The reverse of the process
just described would get under way. A lot of firms
and households that had been borrowing money
to finance new projects would back off. There
would be a reduced demand for goods. Factories
would slow down with pressure coming off the
product markets and the labor markets. You would
start to see some softness in prices and wages,
and, if the Federal Reserve hung on to interest
rates that were much too high, this process would
In fact, we got into something sort of like this
deflationary spiral at the very beginning of the
Great Depression in 1930, ‘31, and ‘32. The Federal
Reserve held interest rates too high for too long,
and the economy started a downward spiral. We
ended up with a complete collapse of the banking
system and a terrible mess.
So if the Fed tries to put interest rates very
far off of the equilibrium for the economy, we are
going to end up with a big problem, and that is
going to be an economy-wide problem. The Fed’s
responsibility is to try to find that sweet spot
where interest rates lead to balanced growth with
low inflation.
So what can monetary policy do? As you are
well aware, the U.S. economy is today in very,
very good shape. My career as a professional
economist really began in 1963 when I became a
newly minted assistant professor at The Johns
Hopkins University in Baltimore. Since 1963,
the economy has never been in better shape than
it is today. We have a very low unemployment
rate. We have the highest percentage of the population employed that we have had since World
War II. We have a very low inflation rate. We
have good—although not by historic standards
sparkling—growth in real output.
The Fed’s contribution to this process has
been to keep inflation low, to keep the economy
balanced, and that’s what yielded this happy

Economic Growth: Is the Fed Irrelevant?

state of affairs. The economy seems to be pretty
stable. We are not going through cyclical fluctuations. That’s what the Fed can do. If we do our job
well, we have an outcome such as we have today.
I can brag a little because I have nothing to do
with the success. I’ve just arrived. I hope I can
indeed brag a couple of years from now when I
have been here for a while. We shall see.
Think again about some of these urban problems that we talked about a few minutes ago. Why
is it that we have such vigorous development to
the west of the city? Again, just from my wandering around trying to find stores and furniture and
places to explore, why is it that the development
is taking place in outlying areas and we see all
of this apparently abandoned land in the urban
areas? In East St. Louis, across the river, there’s a
glorious view of the St. Louis skyline and the Arch,
and yet it’s a wasteland—or so it seemed from my
driving over there. I hope that is not too strong a
way to characterize that area along the river.
Why this wasteland? Why are people locating
one place rather than another? It has to do, obviously, with the rate of return on investment and
the relative advantages of where you put your
capital. The Federal Reserve is not going to affect
those relative rates of return in one place over
another place. That is not within the Fed’s area
of responsibility.
To use an analogy, today in some parts of
Texas and Arkansas, there is drought. Some
regions have too much rain, but Arkansas and
Texas have drought. The crops are shriveling up.
The Fed can print money, but the Fed can’t
print rain and what those areas need is not more
money—they need rain. It is the same sort of
thing with development here. What we need is
not more money, not easier credit or anything like
that. What we need is to improve the attractiveness of these areas that are not doing so well.
The Fed’s role in the growth process—my
topic three—is significant, but not overwhelming.
Maintaining stable and low inflation is a contribution to efficiency of the economy. Maintaining
an efficient payments mechanism is important.
We take for granted—as we should—that checks
clear, wire transfers work, and that the currency

is sound. A sound payments system is a necessary
basis for much economic activity. You don’t really
realize that until you go to an economy where
the banking system or the monetary system does
not work, such as in Russia today, where there
are big problems with the banking system.
I remember a few years ago traveling to
Romania. My youngest son married a Romanian
woman, and we went there for the wedding. As all
good U.S. travelers do, I took a bunch of traveler’s
checks. I found that it was almost impossible to
cash them in Bucharest at that time. We had to
go through an enormous rigmarole to cash our
traveler’s checks in order to cover some of the
wedding expenses that we had agreed to pay for.
So when you can’t make transactions on a routine
basis, it really does interfere with the efficiency
of the economy.
One of the Fed’s responsibilities, then, is to
make it a matter of course that the payments system works well, and we do a pretty good job of
that. We also have responsibilities for supervising
and regulating banks as part of that same process
of making the financial system work well.
Where does economic growth come from?
The most important thing, of course, is productivity—the increase in output per hour of labor
input. That is where our wealth comes from.

In the United States over the last 150 years or
so, productivity growth—growth of output per
hour of labor input—has been about 2 percent
per year. That means that output per hour doubles
in 35 years. Since 1973 or thereabouts, productivity growth has been more like 1 percent per year.
Now, the difference between 2 and 1 doesn’t sound
like very much, but 1 percent productivity growth
means that output doubles in 70 years. There is a
big difference in a society where output doubles
in 70 years versus 35 years.
From the end of World War II to the early
1970s, we had output growth per hour of labor
input of about 3 percent. Instead of 35 years, out3


put doubles in more like 23 or 24 years. So, if we
need wealth to solve a lot of our problems and to
enjoy the benefits of a wealthy society—and I don’t
just mean material goods per se, but a lot of the
cultural things that we enjoy—productivity growth
is very important. We have been lagging behind
on this front, without any question.
Where does productivity growth come from?
We often focus on big things, like assembly lines
or the invention of the steam engine or the microchip, and obviously those are important. But I
always like to emphasize that of much larger
importance is the accumulation of an enormous
number of little things. You can see this in your
own businesses—the returns you get from the
accumulation of lots of little things.
For example, some years ago, the airlines
installed lighter carpeting in their aircraft to
reduce weight so there would be less fuel usage
and larger payloads. Little things like that. It
doesn’t sound like very much just to install lighter
I remember at the time of the first energy crisis
in 1973 when the fuel prices went up so much,
some of the airlines were taking out some of the
airline magazines and putting them in every
other seat pocket instead of every seat pocket to
save weight. Attention to detail like that is what
I’m talking about.
At our Reserve Bank, we have high-speed
sorting machines for our check operations. We
were having problems with checks jamming and
not feeding through properly. Before putting the
checks on the machine, the machine operator
now puts each box of checks on a vibrator table
that shakes all the checks down so that the edges
are lined up and then they feed through the sorter
properly. This extra step is a simple thing, but it
adds to productivity. The accumulation of ideas
like that, bit by bit, is where productivity comes
from in the long run.


The engine of growth, then, is not what somebody else does. It’s what each of us does in our
own business. In the context of regional development and government policies, it’s not what the
Federal Reserve does, it’s not what the federal
government does, but it’s what our communities
do to make it attractive for people to build here
rather than someplace else. To start to use some
of the idle land in our urban areas is our responsibility and no one else’s.

The Fed’s monetary policy gets a lot of press.
Fed policy is obviously a big issue. Everybody is
interested in where interest rates are going to go
and their impact on the economy. But the most
important contribution is still for the Fed to keep
inflation low. That’s what has produced an economy that is far more stable and has opportunities
for growth without the confusion of changing
currency values. Low inflation has made a major
contribution to the U.S. economy. That’s what the
Fed can deliver, that’s what the Fed’s responsibility is. If we at the Fed can continue to be successful on the inflation front, then we have done
our job well.
Secondly, the Fed’s roles in the payments
process and the supervision of banks are important in helping consumers and businesses function effectively. We have a responsibility to do
our jobs efficiently there, too.
So that’s the bottom line. Our job at the Fed
is to print the right amount of money and if you
walk out of here remembering only one thing,
just remember the Fed can’t print rain.