Ben S Bernanke: Remarks on Class Day 2008
Speech of Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal
Reserve System, at Harvard University, Cambridge, Massachusetts, 4 June 2008.
The original speech, which contains various links to the documents mentioned, can be found on the US Federal Reserve
System's website.
* * *
It seems to me, paradoxically, that both long ago and only yesterday I attended my own
Class Day in 1975. I am pleased and honored to be invited back by the students of Harvard.
Our speaker in 1975 was Dick Gregory, the social critic and comedian, who was inclined
toward the sharp-edged and satiric. Central bankers don't do satire as a rule, so I am going
to have to strive for "kind of interesting".
When I attended Class Day as a graduating senior, Gerald Ford was President, and an
upand-coming fellow named Alan Greenspan was his chief economic adviser. Just weeks
earlier, the last Americans remaining in Saigon had been evacuated by helicopters. On a
happier note, the Red Sox were on their way to winning the American League pennant. I
skipped classes to attend a World Series game against the Cincinnati Reds. As was their
wont in those days, the Sox came agonizingly close to a championship but ended up
snatching defeat from the jaws of victory. On that score, as on others - disco music and Pet
Rocks come to mind - many things are better today than they were then. In fact, that will be
a theme of my remarks today.
Although 1975 was a pretty good year for the Red Sox, it was not a good one for the U.S.
economy. Then as now, we were experiencing a serious oil price shock, sharply rising prices
for food and other commodities, and subpar economic growth. But I see the differences
between the economy of 1975 and the economy of 2008 as more telling than the similarities.
Today's situation differs from that of 33 years ago in large part because our economy and
society have become much more flexible and able to adapt to difficult situations and new
challenges. Economic policymaking has improved as well, I believe, partly because we have
learned well some of the hard lessons of the past. Of course, I do not want to minimize the
challenges we currently face, and I will come back to a few of these. But I do think that our
demonstrated ability to respond constructively and effectively to past economic problems
provides a basis for optimism about the future.
I will focus my remarks today on two economic issues that challenged us in the 1970s and
that still do so today - energy and productivity. These, obviously, are not the kind of topics
chosen by many recent Class Day speakers - Will Farrell, Ali G, or Seth MacFarlane, to
name a few. But, then, the Class Marshals presumably knew what they were getting when
they invited an economist.
Because the members of today's graduating class - and some of your professors - were not
yet born in 1975, let me begin by briefly surveying the economic landscape in the mid-1970s.
The economy had just gone through a severe recession, during which output, income, and
employment fell sharply and the unemployment rate rose to 9 percent. Meanwhile, consumer
price inflation, which had been around 3 percent to 4 percent earlier in the decade, soared to
more than 10 percent during my senior year.1
The oil price shock of the 1970s began in October 1973 when, in response to the Yom
Kippur War, Arab oil producers imposed an embargo on exports. Before the embargo, in
1972, the price of imported oil was about $3.20 per barrel; by 1975, the average price was
nearly $14 per barrel, more than four times greater. President Nixon had imposed
economywide controls on wages and prices in 1971, including prices of petroleum products; in
November 1973, in the wake of the embargo, the President placed additional controls on
petroleum prices.2
As basic economics predicts, when a scarce resource cannot be allocated by
marketdetermined prices, it will be allocated some other way - in this case, in what was to become
an iconic symbol of the times, by long lines at gasoline stations. In 1974, in an attempt to
overcome the unintended consequences of price controls, drivers in many places were
permitted to buy gasoline only on odd or even days of the month, depending on the last digit
of their license plate number. Moreover, with the controlled price of U.S. crude oil well below
world prices, growth in domestic exploration slowed and production was curtailed - which, of
course, only made things worse.
In addition to creating long lines at gasoline stations, the oil price shock exacerbated what
was already an intensifying buildup of inflation and inflation expectations. In another echo of
today, the inflationary situation was further worsened by rapidly rising prices of agricultural
products and other commodities.
Economists generally agree that monetary policy performed poorly during this period. In part,
this was because policymakers, in choosing what they believed to be the appropriate setting
for monetary policy, overestimated the productive capacity of the economy. I'll have more to
say about this shortly. Federal Reserve policymakers also underestimated both their own
contributions to the inflationary problems of the time and their ability to curb that inflation. For
example, on occasion they blamed inflation on so-called cost-push factors such as union
wage pressures and price increases by large, market-dominating firms; however, the abilities
of unions and firms to push through inflationary wage and price increases were symptoms of
the problem, not the underlying cause. Several years passed before the Federal Reserve
gained a new leadership that better understood the central bank's role in the inflation process
and that sustained anti-inflationary monetary policies would actually work. Beginning in 1979,
such policies were implemented successfully - although not without significant cost in terms
of lost output and employment - under Fed Chairman Paul Volcker. For the Federal
Reserve, two crucial lessons from this experience were, first, that high inflation can seriously
destabilize the economy and, second, that the central bank must take responsibility for
achieving price stability over the medium term.
Fast-forward now to 2003. In that year, crude oil cost a little more than $30 per barrel.3 Since
then, crude oil prices have increased more than fourfold, proportionally about as much as in
the 1970s. Now, as in 1975, adjusting to such high prices for crude oil has been painful. Gas
prices around $4 a gallon are a huge burden for many households, as well as for truckers,
manufacturers, farmers, and others. But, in many other ways, the economic consequences
have been quite different from those of the 1970s. One obvious difference is what you don't
see: drivers lining up on odd or even days to buy gasoline because of price controls or signs
at gas stations that say "No gas." And until the recent slowdown - which is more the result of
conditions in the residential housing market and in financial markets than of higher oil prices
- economic growth was solid and unemployment remained low, unlike what we saw following
oil price increases in the '70s.
For a central banker, a particularly critical difference between then and now is what has
happened to inflation and inflation expectations. The overall inflation rate has averaged about
3-1/2 percent over the past four quarters, significantly higher than we would like but much
less than the double-digit rates that inflation reached in the mid-1970s and then again in
1980. Moreover, the increase in inflation has been milder this time - on the order of 1
percentage point over the past year as compared with the 6 percentage point jump that
followed the 1973 oil price shock.4 From the perspective of monetary policy, just as important
as the behavior of actual inflation is what households and businesses expect to happen to
inflation in the future, particularly over the longer term. If people expect an increase in
inflation to be temporary and do not build it into their longer-term plans for setting wages and
prices, then the inflation created by a shock to oil prices will tend to fade relatively quickly.
Some indicators of longer-term inflation expectations have risen in recent months, which is a
significant concern for the Federal Reserve. We will need to monitor that situation closely.
However, changes in long-term inflation expectations have been measured in tenths of a
percentage point this time around rather than in whole percentage points, as appeared to be
the case in the mid-1970s. Importantly, we see little indication today of the beginnings of a
1970s-style wage-price spiral, in which wages and prices chased each other ever upward.
A good deal of economic research has looked at the question of why the inflation response to
the oil shock has been relatively muted in the current instance.5 One factor, which illustrates
my point about the adaptability and flexibility of the U.S. economy, is the pronounced decline
in the energy intensity of the economy since the 1970s. Since 1975, the energy required to
produce a given amount of output in the United States has fallen by about half.6 This great
improvement in energy efficiency was less the result of government programs than of steps
taken by households and businesses in response to higher energy prices, including
substantial investments in more energy-efficient equipment and means of transportation.
This improvement in energy efficiency is one of the reasons why a given increase in crude oil
prices does less damage to the U.S. economy today than it did in the 1970s.
Another reason is the performance of monetary policy. The Federal Reserve and other
central banks have learned the lessons of the 1970s. Because monetary policy works with a
lag, the short-term inflationary effects of a sharp increase in oil prices can generally not be
fully offset. However, since Paul Volcker's time, the Federal Reserve has been firmly
committed to maintaining a low and stable rate of inflation over the longer term. And we
recognize that keeping longer-term inflation expectations well anchored is essential to
achieving the goal of low and stable inflation. Maintaining confidence in the Fed's
commitment to price stability remains a top priority as the central bank navigates the current
complex situation.
Although our economy has thus far dealt with the current oil price shock comparatively well,
the United States and the rest of the world still face significant challenges in dealing with the
rising global demand for energy, especially if continued demand growth and constrained
supplies maintain intense pressure on prices. The silver lining of high energy prices is that
they provide a powerful incentive for action - for conservation, including investment in
energy-saving technologies; for the investment needed to bring new oil supplies to market;
and for the development of alternative conventional and nonconventional energy sources.
The government, in addition to the market, can usefully address energy concerns, for
example, by supporting basic research and adopting well-designed regulatory policies to
promote important social objectives such as protecting the environment. As we saw after the
oil price shock of the 1970s, given some time, the economy can become much more
energyefficient even as it continues to grow and living standards improve.
Let me turn now to the other economic challenge that I want to highlight today - the
productivity performance of our economy. At this point you may be saying to yourself, "Is it
too late to book Ali G?" However, anyone who stayed awake through EC 10 understands
why this issue is so important.7 As Adam Smith pointed out in 1776, in the long run, more
than any other factor, the productivity of the workforce determines a nation's standard of
living.
The decades following the end of World War II were remarkable for their industrial innovation
and creativity. From 1948 to 1973, output per hour of work grew by nearly 3 percent per year,
on average.8 But then, for the next 20 years or so, productivity growth averaged only about
1-1/2 percent per year, barely half its previous rate. Predictably, the rate of increase in the
standard of living slowed as well, and to about the same extent. The difference between 3
percent and 1-1/2 percent may sound small. But at 3 percent per year, the standard of living
would double about every 23 years, or once every generation; by contrast, at 1-1/2 percent,
a doubling would occur only roughly every 47 years, or once every other generation.
Among the many consequences of the productivity slowdown was a further complication for
the monetary policy makers of the 1970s. Detecting shifts in economic trends is difficult in
real time, and most economists and policymakers did not fully appreciate the extent of the
productivity slowdown until the late 1970s. This further influenced the policymakers of the
time toward running a monetary policy that was too accommodative. The resulting
overheating of the economy probably exacerbated the inflation problem of that decade.9
Productivity growth revived in the mid-1990s, as I mentioned, illustrating once again the
resilience of the American economy.10 Since 1995, productivity has increased at about a
2-1/2 percent annual rate. A great deal of intellectual effort has been expended in trying to
explain the recent performance and to forecast the future evolution of productivity. Much very
good work has been conducted here at Harvard by Dale Jorgenson (my senior thesis adviser
in 1975, by the way) and his colleagues, and other important research in the area has been
done at the Federal Reserve Board.11 One key finding of that research is that, to have an
economic impact, technological innovations must be translated into successful commercial
applications. This country's competitive, market-based system, its flexible capital and labor
markets, its tradition of entrepreneurship, and its technological strengths - to which Harvard
and other universities make a critical contribution - help ensure that that happens on an
ongoing basis.
While private-sector initiative was the key ingredient in generating the pickup in productivity
growth, government policy was constructive, in part through support of basic research but
also to a substantial degree by promoting economic competition. Beginning in the late 1970s,
the federal government deregulated a number of key industries, including air travel, trucking,
telecommunications, and energy. The resulting increase in competition promoted cost
reductions and innovation, leading in turn to new products and industries. It is difficult to
imagine that we would have online retailing today if the transportation and
telecommunications industries had not been deregulated. In addition, the lowering of trade
barriers promoted productivity gains by increasing competition, expanding markets, and
increasing the pace of technology transfer.12
Finally, as a central banker, I would be remiss if I failed to mention the contribution of
monetary policy to the improved productivity performance. By damping business cycles and
by keeping inflation under control, a sound monetary policy improves the ability of
households and firms to plan and increases their willingness to undertake the investments in
skills, research, and physical capital needed to support continuing gains in productivity.
Just as the productivity slowdown was associated with a slower growth of real per capita
income, the productivity resurgence since the mid-1990s has been accompanied by a pickup
in real income growth. One measure of average living standards, real consumption per
capita, is nearly 35 percent higher today than in 1995. In addition, the flood of innovation that
helped spur the productivity resurgence has created many new job opportunities, and more
than a few fortunes. But changing technology has also reduced job opportunities for some
others - bank tellers and assembly-line workers, for example. And that is the crux of a whole
new set of challenges.
Even though average economic well-being has increased considerably over time, the degree
of inequality in economic outcomes over the past three decades has increased as well.
Economists continue to grapple with the reasons for this trend. But as best we can tell, the
increase in inequality probably is due to a number of factors, notably including technological
change that seems to have favored higher-skilled workers more than lower-skilled ones. In
addition, some economists point to increased international trade and the declining role of
labor unions as other, probably lesser contributing factors.
What should we do about rising economic inequality? Answering this question inevitably
involves difficult value judgments and tradeoffs. But approaches that inhibit the dynamism of
our economy would clearly be a step in the wrong direction. To be sure, new technologies
and increased international trade can lead to painful dislocations as some workers lose their
jobs or see the demand for their particular skills decline. However, hindering the adoption of
new technologies or inhibiting trade flows would do far more harm than good over the longer
haul. In the short term, the better approach is to adopt policies that help those who are
displaced by economic change. By doing so, we not only provide assistance to those who
need it but help to secure public support for the economic flexibility that is essential for
prosperity.
In the long term, however, the best way by far to improve economic opportunity and to
reduce inequality is to increase the educational attainment and skills of American workers.
The productivity surge in the decades after World War II corresponded to a period in which
educational attainment was increasing rapidly; in recent decades, progress on that front has
been far slower. Moreover, inequalities in education and in access to education remain high.
As we think about improving education and skills, we should also look beyond the traditional
K-12 and 4-year-college system - as important as it is - to recognize that education should
be lifelong and can come in many forms. Early childhood education, community colleges,
vocational schools, on-the-job training, online courses, adult education - all of these are
vehicles of demonstrated value in increasing skills and lifetime earning power. The use of a
wide range of methods to address the pressing problems of inadequate skills and economic
inequality would be entirely consistent with the themes of economic adaptability and flexibility
that I have emphasized in my remarks.
I will close by shifting from the topic of education in general to your education specifically.
Through effort, talent, and doubtless some luck, you have succeeded in acquiring an
excellent education. Your education - more precisely, your ability to think critically and
creatively - is your greatest asset. And unlike many assets, the more you draw on it, the
faster it grows. Put it to good use.
The poor forecasting record of economists is legendary, but I will make a forecast in which I
am very confident: Whatever you expect your life and work to be like 10, 20, or 30 years from
now, the reality will be quite different. In looking over the 30th anniversary report on my own
class, I was struck by the great diversity of vocations and avocations that have engaged my
classmates. To be sure, the volume was full of attorneys and physicians and professors as
well as architects, engineers, editors, bankers, and even a few economists. Many listed the
title "vice president," and, not a few, "president." But the class of 1975 also includes those
who listed their occupations as composer, environmental advocate, musician, playwright,
rabbi, conflict resolution coach, painter, community organizer, and essayist. And even for
those of us with the more conventional job descriptions, the nature of our daily work and its
relationship to the economy and society is, I am sure, very different from what we might have
guessed in 1975. My point is only that you cannot predict your path. You can only try to be as
prepared as possible for the opportunities, as well as the disappointments, that will come
your way. For people, as for economies, adaptability and flexibility count for a great deal.
Wherever your path leads, I hope you use your considerable talents and energy in
endeavors that engage and excite you and benefit not only yourselves, but also in some
measure your country and your world. Today, I wish you and your families a day of joyous
celebration. Congratulations.
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