The Role of Monetary Policy
As must be apparent, the challenges I have discussed are not susceptible to easy or rapid solution. It is equally apparent that monetary policy cannot be the only, or even the principal, tool in addressing these challenges. But that is not to say it is irrelevant. There is not as sharp a demarcation between cyclical and structural problems as is sometimes suggested. Monetary policies directed toward achieving the statutory dual mandate of maximum employment and price stability can help reduce underemployment associated with low aggregate demand. And, to the degree that monetary policy can prevent cyclical phenomena such as high unemployment and low investment from becoming entrenched, it might be able to improve somewhat the potential growth rate of the economy over the medium term.
More generally, reducing labor market slack can help lay the foundation for a more sustained, self-reinforcing cycle of stronger aggregate demand, increased production, renewed investment, and productivity gains. Similarly, a stronger labor market can provide a modest countervailing factor to income inequality trends by leading to higher wages at the bottom rungs of the wage scale.
The very accommodative monetary policy of the past five years has contributed significantly to the extended, moderate recoveries of gross domestic product (GDP) and employment. To this point, however, there has not been a corresponding upturn in wages. To be sure, there have been notable wage increases in specific areas of the country enjoying economic growth much higher than the national average. And, as is nearly always the case, labor shortages in discrete skilled job categories may be placing some upward pressures on wages for those jobs (though, judging by such aggregate data as we have, not by as much as one might have thought based on the widespread anecdotal reports of skilled labor shortages).
But one sees only the earliest signs of a much-needed, broader wage recovery. Compensation increases have been running at the historically low level of just over 2 percent annual rates since the onset of the Great Recession, with concomitantly lower real wage gains. The reasons for the lag in wage gains in the context of continuing moderate growth are not totally clear. Nominal wage rigidity on the downside may have played a role to the extent that employers were reluctant to cut nominal wages even in the period from late 2008 to early 2009, when they were eliminating jobs in staggering numbers. The secular labor market factors mentioned earlier are also likely relevant.
There is, of course, also a debate around the question of how much of current unemployment--particularly long-term unemployment — is structural and thus how much slack still exists in labor markets. Last week Chair Yellen explained why substantial slack very likely remains. I would add to her explanation only the observation that, in the face of some uncertainty as to how best to measure slack, we are well advised to proceed pragmatically. We should remain attentive to evidence that labor markets have actually tightened to the point that there is demonstrable inflationary pressure that would place at risk maintenance of the FOMC's stated inflation target (which, of course, we are currently not meeting on the downside). But we should not rush to act preemptively in anticipation of such pressures based on arguments about the potential increase in structural unemployment in recent years.
In this regard, the issue of how much structural damage has been suffered by the labor market is of less immediate concern today in shaping monetary policy than it might have been had we experienced a period of rapid growth during the recovery. Remember that, just a few years ago, many forecasters--in and out of the Federal Reserve--were projecting growth rates at an annualized rate of 4 percent or greater for at least a year. That expectation raised the question of whether a reasonably rapid tightening in monetary policy might at some point be needed. But now, in part because we did not have such a spike in the early stages of recovery and instead have had modest growth in place for several years, it seems less likely that we will experience a growth spurt in the next couple of years that would engender concerns about rapid wage pressures and changes in inflation expectations.
The Importance of a National Investment Agenda
In short, by promoting maximum employment in a stable inflation environment around the FOMC target rate, monetary policy can help set the stage for a vibrant and dynamic economy. But there are limits to what monetary policy can do in counteracting the longer-term trends I have discussed. In economic research and in policy debates, we need more focus on these issues and more attention to concrete proposals to address them. I would suggest that one element, though by no means the only one, in such a program is a well-formulated government investment agenda.
A pro-investment policy agenda by the government could help address some of our nation's long-term challenges by promoting investment in human capital, particularly for those who have seen their share of the economic pie shrink, and by encouraging research and development and other capital investments that increase the productive capacity of the nation.
There is already a well-known list of investments that have been shown to be successful. For instance, early childhood education can increase the educational attainment of children from low-income families as well as improve other outcomes. In addition, recent innovations in job training programs, which more tightly link the training to the needs of employers in sectors of the economy with a demand for workers, have been shown to increase both the employment and wages of participants.
Investment in basic research by the federal government is another area in which greater investments could yield significant returns and in which a public policy role is warranted because of externalities. Econometric studies suggest that the rates of return to this type of investment can be very high. And a range of policy commentators agree that there is a continuing role for government investment in infrastructure, including various forms of transportation, as a way to enhance productivity. Not too long ago, the American Society of Civil Engineers gave the United States a rating of D on its roads and bridges. Improving that system, both by doing necessary maintenance to maintain safety and functionality and by reducing congestion could yield substantial benefits.
This agenda might sound ambitious. In fact, spending in these areas is currently not a very large proportion of federal outlays. For example, the entire federal budget for nondefense research programs — including expenditures on health research, the National Aeronautics and Space Administration, and the National Science Foundation — is only 2 percent of federal spending (or less than 0.4 percent of GDP), well below the share in the 1960s, when we last made a significant effort to advance our capacities in math and science during the era of space exploration. Moreover, spending in these areas has been the target of much of the budget restraint in recent years. Even in the area of physical infrastructure, we have fallen behind past efforts. After a surge associated with fiscal stimulus during the recent recession, public spending on infrastructure has tumbled, resulting in the slowest growth (1 percent) in the state and local capital stock since WWII.
I certainly am not intending here to join the broader debate on fiscal policy, either short or longer term. But I do note that fiscal policymakers could promote the longer-term prospects of the nation by increased spending in areas that are likely to yield increases in living standards. The amount of increased investment spending that could reasonably be absorbed would be quite modest in comparison with the very large amounts associated with major fiscal issues such as health-care expenses. And even a strong investment agenda would not be a complete response to the economic challenges I have discussed. But, like monetary policy, it could play a useful role.
Conclusion
The longer-term challenges to the American economy that I have identified this evening are real. But I certainly do not regard a continuation of these trends as inevitable. On the contrary, the American economy is still possessed of great advantages and potential that, while always and necessarily evolving, have served us well over the years. My principal aims this evening have been, first, to echo those who have been drawing attention to these challenges in recent years and, second, to encourage more discussion and debate of the specific policies that can best help us meet these challenges. As should be apparent in my remarks on monetary policy and an investment agenda, I believe that there are policies already developed and available to us that can contribute to this effort. My hope is that such policies will be pursued and that others, perhaps yet to be developed, will follow.
Editor's Note:
Alphabetical List of Standard Occupational Classifications
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