ms. rivlin reports on the positive perfomance of the us economy and the policies needed to sustain growth in the future testimony of the vice chairman of the board of governors of the us federal reserve system, ms. alice m. rivlin, before the committee on banking and financial services of the us house of representatives on 23 / 7 / 97. i would like to begin by expressing my appreciation to the committee for holding this hearing to solicit a wide range of views on appropriate monetary policy at this extremely favorable moment in our economic history. all too often congressional hearings are called when something bad is happening. in a deteriorating situation, congress finds it necessary to survey the damage, assess responsibility and call for better policies in the future. at the moment, however, the economy as a whole is functioning amazingly well. employment is high and rising, unemployment is low, incomes are increasing, profits are high, the federal budget deficit is plummeting, state and local finances are increasingly strong, and inflation is benign. the overriding economic objective - - shared by all participants in the economy - - is to keep the good news flowing. we all want the economy to grow at its highest sustainable rate, to keep unemployment and inflation low, and above all, to avoid recession as long as possible. thoughtful people, at the federal reserve and elsewhere, have somewhat different views about why the economy is doing so well and how best to keep it going. your invitation to share those views is timely, constructive and welcome. i would like briefly to discuss three questions : 1. 2. 3. why is the economy performing so well - - and, in particular, why do we have so little inflation with such low unemployment? why is it so important, especially right now, to keep the economy growing at its highest sustainable rate and to avoid recession? what policies - - monetary and other economic policies - - are most likely to keep economic performance high and sustained? why is the economy doing so well? most economists are frankly surprised that the economy has been able to grow fast enough to push unemployment rates below 5 percent without generating accelerating inflation. until recently, most students of the economy thought that unemployment rates below 5. 5 - 6. 0 percent ( estimates differed ) for an appreciable period would lead to rising labor costs that would be passed on in higher prices and start a self - perpetuating wage - price spiral that would be hard to reverse. true, unemployment had been lower

in the 1960s while inflation remained low, but the structure of the economy and the characteristics of the labor force subsequently changed in ways that seemed to make the economy more inflation - prone for given levels of unemployment. the experience of the period since about 1970 appeared to confirm that inflationary pressure emerged at unemployment rates appreciably higher than those of the 1960s. five years ago, most economists would have thought the federal reserve irresponsible and derelict in its duty if it had not used monetary policy to slow an economy operating at such a high level that unemployment remained under 5. 5 percent for more than a short time. the inflation might not appear immediately, but it was thought to be inevitable, and allowing it to get up a head of steam before acting was taking a high risk of having to react more strongly, perhaps strongly enough to bring on a recession. nevertheless, the unemployment rate has been below 5. 5 percent for over a year and below 5. 0 percent in 1997 while inflation has shown no signs of picking up - - indeed, producer prices have actually been falling. the federal reserve, except for a quarter point tightening of the federal funds rate in march ( after months of inaction ), has left the monetary levers alone. is the federal reserve ignoring risks of future inflation? the answer depends on whether the coexistence of higher growth and lower unemployment with benign inflation is explained by a fundamental improvement in the structure of the economy making it less inflation - prone, or by temporary factors that might return to “ normal ” and kick - off an inflationary wage - price spiral, or by some combination of the two. the honest answer is : we don't know yet. one surprise has been that such tight labor markets have not resulted in more rapid increases in wages and other labor compensation. part of the explanation, as chairman greenspan noted in his testimony on july 22, may lie in less aggressive behavior on the part of workers. workers may be more reluctant than previously to bargain for higher compensation or to take drastic action, such as striking or quitting to look for a better job. they may be reluctant because they are insecure in the face of rapidly changing technology, for which they fear they may not have the right skills, because they have recent memories of company “ downsizing, ” or because they are less likely than in previous tight labor markets to be members of a union. these explanations of less aggressive worker behavior are plausible, but likely to be temporary. workers