Economic Letter

The phenomenal performance of labor productivity that has marked the U.S. since the mid-1990s has not only fostered economic growth and real gains in wages, but it also has kept economists busy trying to understand its underlying causes. Many studies focus on the broad economy and find that information technology (IT) has played a major role.

Although the swings in economic measures during the last recession and recovery were fairly modest, swings in financial markets were quite large. Once financial markets found their footing, after steep losses in 2000-2002, prices on virtually all traded financial claims rose as the economic outlook improved.

Twenty-five years ago, on October 6, 1979, the Federal Reserve adopted new policy procedures that led to skyrocketing interest rates and two back-to-back recessions but that also broke the back of inflation and ushered in the environment of low inflation and general economic stability the United States has enjoyed for nearly two decades. The dramatic policy actions by the Federal Reserve in 1979 represented an important break with the past, both in the way monetary policy was conducted and in the importance placed on controlling inflation.

In the financial services industry, outsourcing has been in use for quite some time. For example, since the 1970s, financial institutions have used outside firms for such clerical activities as printing customer financial statements and storing records.

Based on the latest data and forecasts from Japan, it would be premature to declare the end of that country’s deflationary period. The Bank of Japan (BOJ) forecasts that consumer prices will continue to fall through the 2004 fiscal year, which ends in March 2005, albeit only at a 0.1% to 0.2% annual pace.

As the U.S. economy becomes more “knowledge-based,” the decisions that policymakers and firms make about spending on research and development (R&D) take on increasing significance. In making those decisions, an important dynamic of R&D to consider is that most innovations borrow heavily from prior or related work; this implies that enhancing the potential for such “spillovers” from one researcher’s innovative efforts to another’s could make R&D more productive.

This Economic Letter is adapted from remarks delivered to the International Financial Institutions Association of California and the National Association of Chinese American Bankers in Santa Monica, California, on October 15, 2004.

A recent front-page article in the Wall Street Journal documented an increasing tendency among economists to move away from theories of efficient stock market valuation in favor of “behavioral” models that emphasize the role of irrational investors (see Hilsenrath 2004). The long-run rate of return on stocks is ultimately determined by the stream of corporate earnings distributions (cash flows) that accrue to shareholders.

Policymakers and forecasters pay close attention to a lot of indicators that help them understand the economy’s current condition and the conditions that are likely to prevail in the future. One of the key indicators is not a so-called “hard” statistic, like “Real Gross Private Domestic Investment.”

In recent months, some Federal Reserve officials have discussed the organization’s efforts at communicating to make the foundations of their decisionmaking more transparent to the public. Janet Yellen, president of the Federal Reserve Bank of San Francisco, said, “The reason for the focus on communication is that economic developments are affected by longer-term interest rates, equity values, the exchange rate, and other asset values—and these factors depend not only on the current [federal] funds rate, but, more importantly, on the expected future path of the funds rate” (Yellen 2004).