The U.S. in 2001: Macroeconomic Policy and the New Economy

The U.S. in 2001: Macroeconomic Policy and the New Economy

1. How do you explain the remarkably strong performance of the US economy during the late 1990s? Please include in your response the favorable macroeconomic circumstances that contributed to such strong performance.

Between 1995 and 2000, real GDP grew an average of more than 4.5% per year. In addition, the US unemployment rate fell from its high of 7.5% in 1992 down to 4.2% in 1999. And finally, despite the high resource utilization rates during this time period, the net price inflation rate had also slowed (Pill, 2001, p. 3-4). This remarkably strong performance of the US economy during the late 1990s can be explained through three interrelated factors: technological innovation, organizational changes in business, and public policy (Pill, 2001, p. 7). Together, these factors led to higher efficiency and an increased productive capacity of the American economy (Pill, 2001, p. 1).

In the early 1990s, advances in information technology resulted in new technologies being combined in ways that drastically increased their economic potential. To realize the increased economic potential, entrepreneurs changed their organizations, either through reconfiguration or by starting new businesses that involved combinations of the newly available technologies (Pill, 2001, p. 7). There became a focus on efficiency and the corresponding result was faster productivity growth in the economy. Specifically, between 1995 and 2000, there was about a 3% annual increase in the output per hour in the non-farm business sector, which is a standard measure of productivity (Pill, 2001, p. 4). The rapid technological changes made it more profitable to invest in capital goods that embodied the new technologies. As a result, businesses took advantage of this opportunity through the acceleration of capital spending. Consequently, the increased spending on capital goods generated employment and income, which in turn resulted in increased consumer spending. Referred to as the “multiplier-accelerator” effect, another round of investment spending would be set off and this cycle would continue so long as a new capital project’s real rate of return was greater than its cost (Pill, 2001, p. 4). In other words, the technological innovations during this time caused an outward shift in the long run aggregate supply curve (LRAS) as they allowed for greater, more efficient production and increased the potential output in the economy. This positive, permanent shock on the supply side led to both increased output and decreased prices.

The strong drive for efficiency and productivity in the late 1990s caused there to be downward pressure on prices, which resulted in a decrease in both costs and prices. In the entrepreneur-friendly capital market of the US, more money was being invested in New Economy companies, allowing them to grow stronger. The result was that the