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