Federal Reserve Chairman Alan Greenspan said last night that the revised economic growth figures released yesterday by the Commerce Department make it clear that U.S. labor productivity gains have accelerated sharply, allowing the economy and American living standards to grow more rapidly than in the two previous decades.
Nevertheless, Greenspan told a gathering of corporate executives in Boca Raton, Fla., "consumer demand can accelerate so much" that, even with large productivity gains, demand can outstrip the economy's ability to produce goods and services without causing inflationary pressures to rise. "This seems to have been happening in recent years, owing to an expanding net worth of households relative to income," he said.
The Fed chairman reiterated a warning that this situation cannot continue indefinitely, but for the first time he also said that market forces have begun to "contain" this excessive growth of demand.
In last night's speech, Greenspan never mentioned the level of stock prices, even though the principal source of the rise in wealth that he believes has boosted household net worth in recent years has been the soaring stock market. When he has mentioned the market in other recent speeches, his comments have usually triggered a sharp market sell-off.
The principal restraining force now at work, Greenspan said, is a rise in market-determined interest rates. Since 1997, rates on inflation-indexed Treasury notes have increased by about half a percentage point. Meanwhile, the spread between yields on Treasury securities and corporate bonds has also widened.
"As a consequence of these higher real interest rates, the ratio of net worth to income for the average household is already lower than it was earlier this year," Greenspan said. He did not mention that the reason the ratio has declined has been the drop in stock prices since July.
If indeed it has been the growth of such wealth that has been driving consumer demand, however, then presumably future increases in consumer spending will be smaller than they have been.
But the Fed chairman added cautiously: "We do not have enough experience with technology-driven gains in productivity growth to have a useful sense of the time frame in which market pressures contain demand. Moreover, it is not clear as yet how much cumulative impact the rise in real long-term interest rates over the past two years will have on future demand."
Going forward, he indicated, the Fed will be keeping a wary eye on the extent to which higher market-determined rates are cooling rising consumer demand. At the same time, he and his colleagues will be monitoring "the evolving capacity of our economy to meet higher levels of demand"--that is, how fast productivity is growing. And while he didn't spell it out, if more restraint seems to be needed, the Fed presumably would raise short-term interest rates to provide it.
Despite his warnings, Greenspan emphasized how much the productivity picture has changed in recent years, particularly with the Commerce Department's revised figures on gross domestic product.
"Gross product per work hour measured for the nonfarm business sector, employing the newly revised data made available this morning, rose an average 2 1/4 percent per year over the past five years, and nearly 2 3/4 percent over the past two, after averaging 1 3/4 percent over the previous two decades," Greenspan told the members of the Business Council, an organization of chief executives of major U.S. corporations.
Other figures are even more compelling, he said. The income numbers that accompany the GDP data show they have been rising about a percentage point faster each year than the GDP itself.
Finally, in the nonfinancial corporate sector of the economy, for which he believes the data are most reliable, Greenspan said, the productivity growth numbers "are still more impressive, nearly 3 percent on average over the past five years, and more than 4 percent over the past two." That compares with average productivity growth in this sector of only about 1 3/4 percent a year in the 1970s and 1980s, he said.