I should note that the course of aggregate demand is not independent of the course of potential aggregate supply. Both economic theory and empirical evidence suggest that households and businesses make decisions about spending with an eye to future incomes and sales, so that a rosier long-term outlook tends to raise demand today. Thus, as the FOMC notes frequently in its statements, robust underlying growth in productivity is providing ongoing support to economic activity...

As with the transition in demand, the transition to less-spectacular growth of potential supply involves important risks. We have been persistently surprised by the extent of the pickup in productivity and could be facing a higher level and growth rate of productivity than many expect. If we are so fortunate as to be confronting these circumstances, policymakers will need to be alert to the need for a faster expansion of aggregate demand to match the stepped-up pace of supply. Conversely, perhaps the transitory factors boosting productivity will recede more sharply than most observers anticipate, and the output gap will close more rapidly. It appears to me that uncertainty in our current situation is at least as great for potential output as it is for demand.

The profitability of the business sector was again propelled by stunning increases in productivity...The vigorous advance in efficiency represents a notable extension of the pickup that started around the mid-1990s. Apparently, businesses are still reaping the benefits of the marked acceleration in technology. The strong gains in productivity, however, have obviated robust increases in business payrolls. To date, the expansion of employment has significantly lagged increases in output...In all likelihood, employment will begin to grow more quickly before long as output continues to expand.

Reports from businesses around the country suggest that the exploitation of available networking and other information technologies was only partially completed when the cyclical retrenchment of the past year began. Many business managers are still of the view, according to a recent survey of purchasing managers, that less than half of currently available new, and presumably profitable, supply-chain technologies have been put into use.

There is nothing inherent in our objective for price stability and what we are trying to do about the purchasing power of money that says that when we have a favorable supply shock we should raise our money growth objectives. There’s no more reason to do that than to cut the money growth targets if we had an adverse supply shock.  We wouldn’t do that. I’m sure that back in the 1970s or the 1980s we didn’t argue for lowering our targets. What we want to do is to view the transitory effects of the acceleration in productivity growth in a lower reported rate of inflation or transitory decline in the price level as an increase in the purchasing power of money. It would be a one-time decline in the price level--I don’t want to use that “D” word. And then when the supply shock goes away, we would return toward the sort of balanced equilibrium that we would have been in.

The Boskin commission, along with most other estimates of bias in the U.S. CPI, have taken a microstatistical approach, estimating separately the magnitude of each category of potential bias. Recent work by staff economists at the Federal Reserve Board has added corroborating evidence of price mismeasurement, using a macroeconomic approach that is essentially independent of the microstatistical exercises. Specifically, employing disaggregated data from the national income and product accounts, this research finds that the measured growth of real output and productivity in the service sector is implausibly weak, given that the return to owners of businesses in that sector apparently has been well-maintained. Indeed, the published data indicate that the level of output per hour in a number of service-producing industries has been falling for more than two decades. It is simply not credible that firms in these industries have been becoming less and less efficient for more than twenty years. Much more reasonable is the view that prices have been mismeasured and that the true quality-adjusted prices have been rising more slowly than the published price indexes. Properly measured, output and productivity trends in these service industries might be considerably stronger than suggested by the published data. Assuming, for example, no change in productivity for these industries would imply a price bias consistent with the Boskin commission findings.