mr mcdonough comments on the implications for the strong us growth for the world economy speech by mr william j mcdonough, president of the federal reserve bank of new york, before the japan center for economic research, tokyo, on 30 march 2000. * * * good afternoon, ladies and gentlemen. it is a great pleasure to be invited to speak before such a distinguished audience. my thanks to the japan center for economic research for extending such a kind invitation. this afternoon i would like to share with you some of my thoughts on the us and the world economies as we move forward into the 21st century. to do so, it is helpful to step back and take a somewhat longer - term view of how the stage was set for much of the current strong economic performance the us economy has enjoyed in recent years. in addition, i would like to comment on the implications of the strong us growth for the world economy. the united states is now experiencing the longest economic expansion in its history. this expansion, which began in april 1991, not only has reached record length, but also has done so in a far stronger manner than had been expected. most notably, inflation has been subdued, notwithstanding the most favorable labor markets that the united states has experienced in a generation, and the country ’ s fiscal accounts are in surplus. there is no question that this expansion reflects some remarkable changes in the us economy. before turning to some of the deeper trends that may help account for the remarkably good performance in the past several years, i think some key points are worth noting. as 2000 gets under way, the us economy continues to enjoy astonishing job growth. payroll employment growth has been fluctuating around 250, 000 jobs per month since early 1996. although job growth in february was considerably more modest, when figures for december and january are included, it looks as though the trend of roughly 250, 000 jobs per month is still in place. the counterpart to strong job growth has been a steady decline in us unemployment rates. in january, unemployment in the united states fell to a 30 - year low of 4 %. this level held roughly steady in february. what is particularly noteworthy is that the percentage of the population employed, at 65 %, is the highest it ’ s been in the postwar period. of considerable importance is the fact that job growth in the last few years has been increasingly centered in the segments of the population in which unemployment has been most stubborn : the more disadvantaged parts of us society, including the inner

provide a liquidity backstop to solvent firms. for example, the central bank could commit to being the lender of last resort as long as it judged the firm to be solvent and with sufficient collateral. this would reduce the coordination problem and the risk of panics sparked by uncertainty among lenders about what other creditors think. if the central bank is willing to provide backstop liquidity, then a lender that judges the financial firm to be solvent should be willing to lend. the backstop liquidity ensures timely repayment. the lender of last resort role eliminates the externality in which the expectations about the willingness of one lender to lend influences the decisions of others. however, providing a liquidity backstop is not without its own set of problems. if firms have liquidity backstops that are viewed as credible, then this creates moral hazard. firms do not have to worry as much about what lenders think about their capital adequacy or the size of their liquidity buffers. this creates incentives to run leaner in terms of capital and liquidity, which increases the risks to the backstop liquidity provider. to mitigate such effects, the backstop liquidity provider could presumably charge financial firms for the value of the backstop. but what fee would be appropriate? it is difficult to assess the probability of financial panics and the value of backstop liquidity facilities. 7 fifth, regulators could take steps to reduce the difference between the value of the firm dead versus alive. for example, we could improve the resolution process so that less of a firm ’ s value is destroyed by the liquidation process. if we could reduce the difference in value between a firm as a going concern versus the same firm in liquidation we could reduce the severity of the cascade effect when financial conditions deteriorate. sixth, we could make structural changes to the financial system to make it more stable in terms of liquidity provision. for example, consider the three structural issues outlined earlier that amplified the crisis – tri - party repo, collateral requirements tied to credit ratings, and haircut spirals. in the case of tri - party repo, the amplifying dynamics could be reduced by enforcing standards that limited the scope of eligible collateral or required more conservative haircuts. formal loss - sharing arrangements among tri - party repo borrowers, investors, and clearing banks might reduce or eliminate any advantage that might stem from running early. eliminating the market ’ s reliance on intraday