The new business cycle: the impact of the application and production of information technology on U.S. macroeconomic stabilization

Business Economics, Oct, 1997 by Martin Fleming

The performance of the U.S. macroeconomy in 1997 has been nothing short of idyllic. Now in the seventh year of expansion, the U.S. economy continues to surprise analysts. This continuing stellar performance has inevitably raised a host of questions. How long can the expansion continue? Has inflation been permanently suppressed? Has the long-term sustainable noninflationary real growth rate increased?

While it is too soon to provide a definitive explanation for this strong performance, the need for both private and public decisionmakers to anticipate the future course of economic events requires at least a tentative explanation. The development of new explanations is especially important when one considers that the past fifteen years have been a period of average growth interrupted only briefly by a recession of moderate depth and duration in 1990. Such economic performance inevitably raises the issue of how sanguine one's view of the future should be.

Policymakers are, of course, correct to be cautious about the emergence of new eras. But a chorus of commentators cite fundamental changes in the U.S and global economies that have and will alter economic performance over both the short and long terms. In particular, increasing opportunities for the application of information technology (IT) solutions to business and policy problems as well as the dramatic increase in the employment of human and physical resources in the production of IT solutions may be one of a set of factors contributing to a fundamental alteration of the global economy.

For more than a decade, economists have attempted to measure the impact that IT has had on productivity, especially in the service sector. The purpose of this essay is to take a very different point of view and consider the impact that the increased application of IT solutions may be having on the U.S. macroeconomy. In contrast to the more narrow focus that economists have taken in the past with respect to the impact of IT on productivity, a much broader view is warranted. While its very possible that the increased application of IT solutions on the U.S. and global economies has been both broad and deep and has affected the performance of the economy both over the short term and the long term, this paper considers only a single aspect of these potential changes. In particular, the hypothesis is advanced that the nature of the business cycle has changed, particularly in the United States, in part as a result of the dynamics of both the production and application of IT.

EXPLANATIONS OF THE IMPACT OF INFORMATION TECHNOLOGY

Theories related to the impact that IT has had on the U.S. and global economies have generally fallen into two categories:

1. The benefits of IT are due to the ability of the economy to realize stronger noninflationary growth over the short term.

2. The benefits of IT are due to stronger long-term growth, irrespective of how events may unfold over the course of the business cycle.

The capacity of the U.S. and global economies to experience stronger year-to-year growth over the course of the business cycle is, of course, at the heart of the problem facing macroeconomic policymakers. Recently many influential business leaders, journalists and public officials have suggested that the maximum sustainable growth rate of the U.S. economy has increased. Over the past twenty years or so, it has been widely believed that if economic growth continues above a rate of 2.5 to 3.0 percent for a prolonged period, high inflation and a correction in the form of a deep and sustained recession would result. However, during the past year or so an alternative view has emerged that asserts an increase in the maximum sustainable noninflationary growth rate.

The new view, which Krugman calls the New Paradigm, claims that the increased application of IT and the increased volume of international trade and investment have altered the fundamental capacity of the economy to grow in an noninflationary way. Rapid technological change means very basic restructuring of business processes and thus more rapid capacity expansion to meet the demands of a more rapidly growing economy. Improved inventory management systems have enhanced the ability of firms to balance supply and demand better. In addition, growing international trade and investment permits the introduction of global capacity into markets straining to meet demand in cross-global geographies. Further, even in the face of tightened markets, increased global competition severely limits the ability of firms to respond with increased prices and of workers and managers to demand increased salaries and wages. Consequently, attempts by the Federal Reserve to limit average growth rates to 2.2 to 2.3 percent over a period of years only steals income and wealth from the U.S. economy and transfers the income and wealth that rightly belongs in the United States to foreign economies.

While it is undoubtedly true that rapid technological change, the increased use of IT, increased international trade and investment as well as increased global competition have conferred economic benefits on the U.S. economy, it is also true that there is no such thing as the free lunch the New Paradigm would seen to suggest. The dramatically altered economic and technologic forces that the New Paradigm relies on may well have increased the length of the expansionary period before capacity limits are reached and strong inflationary pressures emerge. However, marginal changes in service-sector productivity growth and even smaller increases in labor force growth are difficult to see and measure, even with the best measurement programs, and, further, the New Paradigm ignores the subtleties of the working of the macroeconomy.