Knowledge that Transforms

The author reviews the latest information on productivity and the alternative explanations of the slowdown, which he concludes was partially due to a decline in innovation and work effort and mostly due the post 1973 energy price increases. Identical policy responses to the worldwide inflation were also a reason why so many countries experienced slow growth at the same time, as cyclical productivity declines were added to the structural decline. There are signs that productivity growth is recovering, which gives credence to the view that the temporary shocks of the 1970s were the culprit.

It has now been a decade since the first of the variance-bounds papers was circulated in typescript. If initially less interest was displayed in this material than the authors had hoped and expected, the same is no longer true. This may be a good time to discuss a few of the many recent papers extending and criticizing the original results. The central idea underlying the variancebounds tests is very simple. Consider stock prices. The perfect foresight price of stock -that price which would prevail if future dividends xt+i were known-is

This paper deals with the design of optimal monetary policy and with the interaction between the optimal degrees of wage indexation and foreign exchange intervention. The model is governed by the characteristics of the stochastic shocks which affect the economy and by the information set that individuals possess. Because of cost of negotiations, nominal wages are assumed to be precontracted and wage adjustments follow a simple indexation rule that links wage changes to observed changes in price. The use of the price level as the only indicator for wage adjustments may not permit an efficient use of available information and, may result in welfare loss. The analysis specifies the optimal set of feedback rules that should govern policy aiming at the minimization of the welfare loss. These feedback rules determine the optimal response of monetary policy to changes in exchange rates, interest rates and foreign prices. The adoption of the optimal set of feedback rules results in the complete elimination of the welfare cost arising from the simple indexation rule and from the existence of nominal contracts. Since optimal policies succeed in the elimination of the distortions, issues concerning the nature of contracts and the implications of specific assumptions about disequilibrium positions become inconsequential. The analysis then proceeds to examine the interdependence between the optimal feedback rules and the optimal degree of wage indexation. It is shown that a rise in the degree of exchange rate flexibility raises the optimal degree of wage indexation. One of the key conclusions is the proposition that the number of independent feedback rules that govern a policy must equal the number of independent sources of information that influence the determination of the undistorted equilibrium. Thus, it is shown that with a sufficient number of feedback rules for monetary policy there may be no need to introduce wage indexation. It is also shown that an economy that is not able to choose freely an exchange rate regime can still eliminate the welfare loss by supplementing the(constrained) monetary policy with an optimal rule for wage indexation. The paper concludes with an examination of the consequences of departures from optimal policy by comparing the welfare loss resulting from the imposition of alternative constraints on the degree of wage indexation, on foreign exchange intervention and on the magnitudes of other policy feedback coefficients.

Budget decision making at the federal level in the United States can hardly be described as casual, haphazard, or ill-informed. The budgeting process is lengthy and elaborate. The principal decision makers-the president and the Congress-are assisted at every stage by an army of highly trained economists and budget analysts who assemble masses of information, use sophisticated forecasting models, and have access to state-of-the-art computers. Everyone works very hard. No government in the world devotes as much time, energy, and talent to budget decision making as our's does. Nevertheless, almost everyone is unhappy, with both the outcome of all of this effort and the process itself. Of course, some dissatisfaction with the outcome is normal. No matter how smoothly the mechanics of budget decision making are carried out, some will feel that the government spends too much or too little, spends on the wrong things, or taxes in the wrong way. But the current situation is not normal. Unless recent budget decisions are changed, they will lead to high and rising structural deficits that almost no one defends as desirable fiscal policy, a rapidly escalating burden of debt service, and a mix of fiscal and monetary policies that is reducing U.S. competitiveness in international markets and seems likely to retard growth. Moreover, quite apart from its unsatisfactory outcome, both participants and observers decry the shortcomings of the budget-making process itself. Budget decision documents are complex, technical, and difficult to understand. Even the experts have a hard time following what is going on. There never seems to be enough time for debate or deliberate decision making at any stage of the process, but the whole process takes too much time. Executive officials and members of Congress seem to do nothing but defend, question, and debate the budget and still they never finish before the budget year begins-and sometimes not before it ends. On top of all this, the economic assumptions are always proving wrong. Decisions are out of date almost before they are made. It is all very frustrating. It is tempting to ask whether there are not some procedural reforms that could solve all of these problems. Couldn't we change the budgeting process so that it would be easier to understand, less time consuming, less uncertain, and, above all, less prone to produce large budget deficits? I will argue that our current problems are not primarily procedural. The budgeting process is complex and time consuming primarily because the federal government does so many different kinds of things, and because Congress is so reluctant to concentrate on major directions of policy while leaving the details to executive departments or state and local governments. We can simplify the budget process only by simplifying the government itself and changing the role of the Congress. We can make the budget process less time consuming only if we are willing to make decisions less often, or to give up some checks and balances. Moreover, the world is an unpredictable place, and, while we could perhaps handle unpredictability in the budget process better than we do, no procedural changes can eliminate it. Nor does the failure to make the hard decisions neces* Director, Economics Studies Program, The Brookings Institution, 1775 Massachusetts Avenue, NW, Washington, D.C. 20036. The views expressed in this paper are my own and should not be ascribed to the officers, trustees, or other staff members of the Brookings Institution.