Macroeconomic Implications of the New Economy

58 Pages Posted: 16 Feb 2002

See all articles by Martin Neil Baily

Martin Neil Baily

Institute for International Economics; University of Maryland


Together with many policymakers and economists, I see in the 1990s expansion signs that new technologies that had been emerging for some time were finally paying off in stronger economic performance. I will use the expression 'new economy' to describe this period, although I recognize the pitfalls in this name. New economy is probably too broad a term and implies both more change and more permanent change than actually took place. But 'information economy' seems too narrow a term to describe the set of interrelated forces bringing about change in the economy, that include increased globalization, a more intense pressure of competition, the rapid development, adoption and use of information and communications technology (IT) and a favorable economic policy environment.

The paper is a survey, drawing on a range of literature and covering a variety of topics. The goal is to give the reader a sense of some of the macroeconomic issues that have developed as a result of the surprising economic performance of the 1990s expansion, including some sense of what is known and not known about accelerated productivity growth, the key driver of the new economy.

With the license of a survey paper I have not tried to tell a linear story or link each section of the paper together, but there are, nonetheless, two main themes. The first is to explore the relation between IT, on the one hand, and economic performance on the other. One view of the new economy is that it reflects an exogenous surge in innovation and capability in the high-tech sector. That view is not simply wrong, but it is seriously misleading. It is misleading because the innovations that are required to make productive use of IT are as important as the high-tech innovations themselves. It is misleading because innovation is strongly demand driven, so that the old or traditional economy was a vital driver of innovation in high-tech. It is misleading because the overall economic and policy environment is essential if high-tech innovation is to translate into superior economic growth. In particular, a highly competitive economic environment in which new companies enter and expand and old companies contract or die is one that fosters the adoption of innovation.

The second theme of the paper is to emphasize the uncertainty that currently surrounds the new economy and how much hangs on whether or not it continues. IT has been around for a long time and will continue to contribute to the economy for some time to come. But the period over which innovation has translated into accelerated productivity growth is very short-a mere five years. The Economic Report of the President in January 2001 described the uncertainty involved: "The fact of a shift in the trend of structural productivity growth does not tell us how permanent that shift will turn out to be... We could be observing not a long-term shift to a faster productivity growth rate but simply a shift to a higher level of productivity, with faster growth for a while followed by a return to the pre-1995 trend." (28)

Faster productivity growth has translated into lower unemployment and inflation and greatly improved real wages. It has been a key factor behind the strength of the stock market, the rapid inflow of foreign capital and the strong dollar. If the productivity growth trend falters going forward, the adjustment that the US economy would have to go through would be painful. This paper was delivered at the conference prior to the terrorist attack of September 11, 2001. At this time it is not clear how this will affect the US and the global economy. At the very least, it increases the uncertainty of the economic outlook.

Suggested Citation

Baily, Martin Neil, Macroeconomic Implications of the New Economy. Available at SSRN: or

Martin Neil Baily (Contact Author)

Institute for International Economics ( email )

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Washington, DC 20036-1903
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University of Maryland

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