The U.S. Federal Reserve has a three-pronged mandate for its monetary policy: to maintain maximum employment, stable prices and moderate long-term interest rates. The IT revolution, combined with years of lax monetary and fiscal policy, has created a vicious cycle, making it difficult to reach these three objectives.
Technology has brought to life deflationary forces, which require the central bank to keep interest rates permanently at zero—or negative—and even pump liquidity into the financial system to keep prices from falling. But massive infusions of free money underwrite even more technological progress, which ultimately damages the labor market.
Moreover, given political responses to this economic reality—such as calls for a sharply higher minimum wage—there may be growing pressures on public finances.
In effect, then, both monetary and fiscal policy have been taken out of policy-makers’ hands. In the next economic crisis, their response will be severely weakened and, in John Maynard Keynes’s words, they’ll be “pushing on a string.”
Americans are a nation of inventors and entrepreneurs, with traditions going back to Ben Franklin, Henry Ford and Thomas Edison. The country also has enormous respect for education, creating a unique network of colleges and universities. There are nearly 7,000 accredited postsecondary educational programs; eight out of the top 10 universities in the Shanghai Ranking are American, as are more than half of the top 100.
After World War II, a group of investors backed several startups around Stanford University that were working on early computers, helping create Silicon Valley and laying the foundations for the venture capital industry. Those strands came together in the 1980s to create America’s formidable innovation establishment.
Technology has always had a strong deflationary bias since it boosts productivity and efficiency. The tech revolution of the past three decades has been especially successful in allowing businesses to cut costs—in particular, by making the world economy truly global. Plus, by increasing competition, technology forced businesses to translate their cost savings into lower prices. A mid-1980s leap in computing power correlated closely with the deceleration of inflation. As the revolution progressed, technology itself became cheaper, further spurring deflationary pressures.
Here is the difference: During the 1970s, a tenfold jump in oil prices created an inflationary inferno. A similar increase in the 1999–2008 period didn’t even produce a blip on the radar screen.
The Fed under Alan Greenspan responded to disinflationary trends in the 1990s by gradually easing its monetary policy. For a brief period in the final years of the last century, the Fed achieved a perfect balance: Prices were under control, there was full employment and even a labor shortage, and long bond yields were low. Plentiful liquidity and low interest rates spurred rapid development of information technologies, especially the Internet, but it was seen as a very good thing. There was, as Greenspan put it, “irrational exuberance” on Wall Street, but an asset price bubble didn’t seem to worry the Fed.
That set a pattern we have seen over the past 20 years. First, we have a period of plentiful liquidity, which fuels rapid technological progress and inflates asset price bubbles. But technology keeps inflation under wraps, which gives the Fed a carte blanche to keep interest rates low. Then comes a bust, to which the authorities respond with even lower interest rates and the whole cycle is repeated.
How it works can be seen at Uber, the ride-sharing and taxi service. It is a particularly good example because Uber is one of a handful of tech companies that openly position themselves as “bad.” It has a great idea and in normal times it would have been building up a presence in a couple of markets while gradually improving its system. But these are not normal times. In six years, Uber raised nearly $6 billion in funding—and is eyeing another $2 billion. Backed by unlimited funds, it expanded in 250 markets worldwide, sharply underpricing local taxi companies to snatch riders and offering extraordinary incentives to lure drivers. Largely due to Uber’s low fares, the price of a yellow cab medallion in New York City went down by a third, to around $800,000, in less than two years.