The debate in the USA focuses on  GDP growth in USA percentage change 4  4  3  3  2  2  1  1  0  0  -1  -1  -2  -2  -3  -3 70 72 74 76 78 80 82  84 86 88  90  92  94  96  98  Source: Ecowin  the stock market, which many consider to have been overvalued for a long time, even if there has been a slight fall in the Dow Jones Index recently. The main question at issue seems to be if, and in that case how, a central bank should act when certain asset prices rise very sharply. Alan Greenspan, Chairman of the Fed, has famously said that stock prices seem to be the result of “irrational exuberance”. Although the current discussion of the role of asset prices in monetary policy focuses mainly on the situation in the USA, I think this issue is relevant to the Swedish debate too. For one thing, it is a matter of general interest and of principle, and for another there is no guarantee that, sooner or later, Swedish asset markets will not experience a situation similar to that in the USA today. How do fluctuations in asset prices affect the economy? One question of crucial importance in this connection is how fluctuations in asset prices affect the real economy. There are several different factors involved here.
Some of the factors holding down inflation – such as the cut in Medicare reimbursement rates last April – were one-offs and are now dropping out of the year-over-year figures. In some other areas, such as owners’ equivalent rent, price pressures look likely to firm somewhat. That said, I see little prospect of inflation climbing sharply over the next year or two. There still are considerable margins of excess capacity available in the economy – especially in the labor market – that should moderate price pressures. Most notably, the trend of labor compensation is running at only about a 2 percent annualized pace. This is far below the roughly 3½ percent pace that would be consistent with trend productivity growth of 1 to 1½ percent and the FOMC’s 2 percent inflation objective. Recently, some economists have argued that the amount of slack in the labor market may be smaller than suggested by the official unemployment rate of 6.3 percent. They focus on the level of short-term unemployment – those workers unemployed for less than 27 weeks – which has returned close to its average long-term level – and argue that it is the short-term unemployed that are critical in driving compensation trends. My own reading of this research suggests that one should not jump to such a conclusion. Instead, I conclude: •  The relative impact of each type of unemployment on wages depends on whether long-term unemployment reflects primarily structural or cyclical forces.