In terms of data, however, this is the best we have at the moment. So, notwithstanding substantial data issues, the question is how can we, as policymakers, influence these unobservables? 5  While we can expect a re-launch of capital investment growth, I am quite certain that growth rate that we have witnessed in the 2000s, with strong inflow of FDIs and real estate bubbles in some countries will not be seen again in the near future. That is why so much focus is on the total factor productivity, ultimately seen as the only source of long-term growth. Of course, the TFP is an unobservable variable, usually measured by the Solow residual. What drives the TFP growth is a much trickier question. Is it innovations, technology advances? For us as policy makers, understanding the determinants of technology adoption, the TFP growth, is key, as this gives us the channel to act through. There is an increasing number of theory and empirical papers linking development and the adoption of technologies to the role of institutions defined in a very broad way. And data seem to be supportive of the link – there is a strong positive relationship between the quality of institutions and human capital on one side, and growth on the other. But then, when it comes to the quality of institutions, or human capital, there has been little or no convergence of the CEE.
The initial step in that process was the FOMC’s decisions to first reduce, and then end, its net purchases of Treasury and mortgage-backed securities.2 These purchases pushed longer-term interest rates lower, making it less costly for consumers and businesses to borrow, and contributed to favorable overall financial conditions that supported spending. The next step will be to raise the FOMC’s target range for the federal funds rate the short-term interest rate at which banks lend to each other. In March 2020, the FOMC reduced the target range for the federal funds rate by 1-1/2 percentage points to near zero. This very low interest rate contributed to the sharp rebound in demand, which propelled the strong labor market recovery over the past year. But with today’s strong economy and inflation that is well above our 2 percent longer-run goal, it is time to start the process of steadily moving the target range back to more normal levels. In particular, I expect it will be appropriate to raise the target range at our upcoming meeting in March. Once the interest rate increases are underway, the next step will be to start the process of steadily and predictably reducing our holdings of Treasury and mortgage-based securities, which had grown significantly as a result of the purchases that began in March 2020. Last month, the FOMC released a set of principles that will guide that process.3 Assuming the economy develops roughly as I expect, I foresee this process getting started later this year.