World economy and ®nancial markets

James Tobin*

Yale University PO Box 208281, New Haven, CT 06520-8181, USA

I am going to talk about the present macroeconomic status of the G7, the advanced

capitalist democracies. The United States is the bright star of this group.

In contrast, a few years ago, we Americans had an inferiority complex about macro-

performance. Europe and Japan were thought to manage the governance of corporations

more effectively than we did. We saved and invested less and grew more slowly. Japan and

Germany could not do anything wrong and, in the United States, we were worried about

becoming a low-status member of this fraternity.

Today, it is quite the other way round. On a macrobasis, the United States is close to an

ideal situation: stable economic growth at close to the sustainable rate; low in¯ation and

low unemployment, quite remarkable by previous estimates of how low unemployment can

be sustained in this country without an outburst of extra in¯ation. And now, we have a high

rate of investment too. Even the real wage, which has been the laggard variable in our

economic performance, shows signs of reviving, removing the one indicator on which we

are inferior to the rest of the group.

We know that we still have big economic and social problems. One of the biggest is

America's inequality of income and wealth, which seems to have been increasing in the

recent decade ± both inequality between labor and capital on some counts, and also among

workers. The latter inequality is acute between those with modern skills and education and

those with few up-to-date skills and inadequate education. We also share a chronic problem

of capitalist countries, namely, how to adjust to technological change and other inter-

sectorial shocks that destroy jobs for some people while creating jobs for others. These

shocks change economic priorities among industries and locations.

That has always been true in capitalist countries. Just remember that a third of America's

population was in agriculture only ®ve decades ago. The adjustment from 33 to three

percent occurred successfully. Yet, new adjustments are required all the time. The chronic

problem is ®guring out how to maintain the vitality of a capitalist country in replacing old

industries and technologies with new, without causing a great deal of damage to people

who have vested interests in those technologies that are becoming obsolete. Another

problem we share with other nations these days is what to do about the prospective

Japan and the World Economy 10 (1998) 377±379

* Corresponding author.

0922-1425/98/$19.00 # 1998 Elsevier Science B.V. All rights reserved.

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explosive growth of entitlements, e.g. Social Security, Medicare and Medicaid, in the

coming century.

Going back to our current macrostatus, it certainly has been surprising that we have been

able to get unemployment down well below what used to be thought of as the NAIRU: the

non-accelerating in¯ation rate of unemployment. A horrible, horrible acronym, NAIRU

has been entrenched into the vocabulary. It used to be that six percent was as low as it was

con®dently thought to be. That was certainly the Federal Reserve's view two or three years

ago. But the Federal Reserve had the ¯exibility to change its collective mind, which is very

unusual! And now the Fed and many other economists believe that the lowest in¯ation-safe

unemployment rate is down to below 5.5, maybe 5.4, 5.3 or even 5.0, rather than six

percent. But even now, as we have observed just the other day, we get low unemployment

rates month after month and also low in¯ation rates. And not only low price-in¯ation rates

but also low wage-in¯ation rates, so that it does not look like we are in a dangerous

position. It is quite possible that the Fed could, and maybe should, let the unemployment

rate go down further, even below ®ve percent, and see what happens. It is not as if one step

too far dooms you suddenly to `̀ fall over a cliff'', i.e. face an irretrievable burst of spiralling

in¯ation. The Fed could respond and tighten up a little bit.

There is considerable gain in having lower unemployment rates. They are accompanied

by higher GDP, which among other pleasant side-effects, ®ll the coffers of Federal state,

and local governments (Unfortunately, these pleasant revenue surprises make politicians

think about reducing taxes). There are a lot of other good things that happen. The number of

jobs goes up, not just re-employing people that have been unemployed, but also inducing

and encouraging other people to go into the labor force.

I think Alan Greenspan deserves a great deal of credit for presiding over what has been

certainly the most successful monetary policy operation in the advanced democratic world.

It has been going over the last 10 or 20 years, not only under Greenspan, but also under his

predecessor Paul Volker. I'm not known for handing out praise for Federal Reserve

chairmen, but Greenspan and Volker deserve a great deal of credit for our macropolicies

since 1982±1983 to the present, and we hope beyond.

The contrast is striking with both Europe and Japan. Europe has succeeded in generating

an unemployment problem comparable to that of the Great Depression. It has been going

on year after year, without getting better. In fact, it is getting worse in Germany, France and

most of the rest of Europe. The British broke their tie to the central European currency, the

Deutsche mark, a few years ago and as a result they have done much better, relative to the

economies of the continental countries.

There does not seem to be any economic policy or any political resolution in Europe to

try to do something about this. One aspect of doing something about it might be simply to

adopt concerted stimulative macropolicies, including lower interest rates in Europe and

also some ®scal stimulus, to reduce unemployment.

Europe is in the grips of a theory of what is good economic policy. The doctrine is

basically that no policy is the best macropolicy. That does not seem to have worked. The

outcomes have been getting increasingly worse since 1982, a recession from which

they have never really recovered. Things just go on without anybody seeming to be

seriously concerned, neither the central banks, the ministers of ®nance, nor the chiefs of

government.

378 J. Tobin / Japan and the World Economy 10 (1998) 377±379

They keep saying structural reforms are necessary. They say that, but they do not do

anything. And they are pushing themselves into a corner or, to mix metaphors, into a

straight jacket by the Treaty of Maastricht, which essentially denies to them any possible

®scal policy. To qualify for monetary union, each country has to keep its budget de®cits

under three percent. There is no country in Europe which meets that requirement, along

with a similar requirement on the size of the national debt, other than Luxembourg. Maybe

the U.K. can make it, thanks to its recent macroimprovements.

The United States meets all the Maastricht requirements. We could be in the new

Monetary Union, but they have not invited us in. It has yet to be seen if the new Euro

Central Bank will be as tight as the Bundesbank has been. My guess is that the new Central

Bank will try to show that it is at least that tight. They would not want to be accused of

being soft. Europe will still be in the position of having no freedom of macroeconomic

maneuver. None of the individual countries will, if they join, be able to devalue its currency

ever again, the way the British did a few years ago. They would not be able to have any

monetary policy independent of the European Central Bank, which will likely be an

imitation of the Bundesbank. Nor will there be either any Europe-wide ®scal policy or

macrooriented ®scal policies by the various member states. That does not look very good.

Now Japan, another country that we used to think could do nothing wrong, seems to have

learned how to do everything wrong. In intermediate macrocourses, at least in some

universities or colleges, you are taught that there is such a thing as a `liquidity trap', an

extreme condition that might happen in a deep Depression, according to Keynesian

economics. In that event, interest rates become so low that monetary policy cannot do

anything any more, because you cannot force interest rates any lower than zero. So you are

at a place where monetary policy has lost all of its potency. Japan has succeeded in putting

itself in that position. They do not have any monetary policy left, and they certainly do not

have any ®scal policy because the Ministry of Finance has never allowed Japan to have a

¯exible ®scal policy.

United States now is the only G-7 economy successful in macroeconomic policy.

J. Tobin / Japan and the World Economy 10 (1998) 377±379 379