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The Fed’s search for breakout growth

Models for progress

America’s central bank, like other big financial institutions, seeks fresh ideas to end the ‘new normal’ of mediocre economic growth. Breaking up old models is a good first step.

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    Federal Reserve Chair Janet Yellen testifies on Capitol Hill in Washington in June..
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You won’t see this sign hanging outside America’s central bank but the message coming from the Federal Reserve is still clear: “Help wanted.” No, the Fed does not need workers. Rather, it is looking for fresh ideas.

Despite eight years of a steady but slow expansion of the US economy, the economists who control the levers of the nation’s money supply are in a big internal debate, seeking new ways to end what has been called “the new mediocre” of growth.

The Fed had expected to be raising interest rates by now, based on established models for post-recession growth. But it acknowledges the world has too many uncertainties, from low rates of productivity growth to instability in China and Europe. The 2016 growth forecast for the US economy was recently dropped from 2.4 percent to 2.2 percent. The Fed may – or may not – raise rates in September.

The “old normal” for the Fed’s long-run interest rate was 5 percent. Now it would be happy to reach 3 percent. Fed chief Janet Yellen admits that perhaps there “are factors that are not going to be rapidly disappearing but will be part of the new normal.”

The United States is not the only place in a mood to discover new ideas to break out of the “new normal.”

In a recent speech, Christine Lagarde, managing director of the International Monetary Fund, asked world financial leaders to “think beyond the narrow policy debate we have been having so far.” And the president of the World Bank, Jim Yong Kim, told CNBC in July: “If we wait for growth to pick up, then we’ll know we’ll never get there. So in other words, as the economic model changes, who knows what the next drivers of global economic growth will be?”

For its part, the World Bank is very eager to try new paths. In 2013, it set a goal of ending extreme poverty in the world by 2030. In July, it hired a respected scholar, Paul Romer of New York University, to be its chief economist. If Dr. Romer is known for anything, it is that new ideas can drive prosperity. He came to fame in the 1980s by showing how nations can manage innovation, not wait for it to happen. To achieve that, they must invest in education and research in an open and free society.

Lately, he has shown how cities can become incubators for growth. He points to the success of the Chinese city of Shenzhen in trying many reforms, such as freedom for capital markets, that then spread to other parts of China.

He likes to use a cooking metaphor to say that economic growth springs from new recipes and not only more cooking. He challenges fellow economists by asking questions like “What is the value of an idea?” He recently chided economists for producing studies with too much “mathiness.” Growth comes from how well a nation generates and disseminates new ideas, and less on measurable physical resources.

Too much economic theory is based on how to deal with resource scarcity rather than creating an abundance of ideas, he says. The historic rate of growth in the technological frontier keeps rising, as does the world’s economic growth per capita.

He, like most economists at the world’s major financial institutions, wants to find out how to keep it that way. It is not only the Fed that’s crying for help.

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