Fundamentally, the only realistic choice for policymakers is to equip their economies with the flexibility to cope more successfully in this increasingly integrated global economy. And this means preparing for a world of more rather than less flexibility in exchange rate regimes.

The right macroeconomic policy framework is crucial. But we have come to recognize that other issues, traditionally the province of microeconomics, have a vital role in contributing to effective macroeconomic policy. A critical factor distinguishing long-term economic performance among countries with relatively good monetary and fiscal policies is the degree of overall flexibility they exhibit in labor, product and financial markets. This is not simply about the presence or absence of regulation. It is a function of the incentives regulation creates and the extent to which it gets in the way of competition, impedes the allocation of labor and capital to industries with a higher return, favors established firms, and creates barriers to new entrants.

Although productivity growth has stepped down from the scorching pace seen early in the recovery, factors remain in place for continued solid growth over the next few years. One element is capital deepening, that is, the rate at which the stock of equipment, software, and so forth is expanding relative to the number of workers, or--to put it even more simply, how fast workers are getting more of the tools they need. As I mentioned earlier, business investment spending has been strong in recent years and seems likely to remain at a high level for some time. Another element is improvements in the efficiency of how businesses do business. Here it appears that the flexibility of business processes and product, financial, and labor markets in the United States will continue to allow for the quick adoption of new technologies and the efficient reallocation of resources.

Harvard economist Ken Rogoff and others have pointed out that to the extent that globalization increases the degree of competition, it can reduce the “inflationary bias” or, to put it differently, it can strengthen the anti-inflation credibility of a central bank. By inducing greater price flexibility, competition lowers the short-run gains to output from an unanticipated inflation, and thus permanently reduces the incentives for a central bank to try to exploit those gains. The improved credibility of the central bank’s commitment to keep inflation low and stable should, in turn, allow it to deliver better inflation outcomes with fewer short-run costs to economic growth and employment.

Since 1995, productivity in the United States has grown substantially faster than in other advanced industrial countries.  For example, a recent study by van Ark and Inklaar (2005) indicates that while productivity in the United States accelerated after 1995, average productivity in Europe actually decelerated--indeed, they estimate that the trend in the fifteen countries that made up the European Union before 2004 has been decelerating since the mid-1980s...

Increased trade liberalization, which lowers barriers to the international flow of goods, financial capital, and direct investment, also spurs innovation and creativity....

I draw two conclusions from this work.  First, trade liberalization appears to have made it possible for multinational firms to institute highly efficient cross-border supply chains within their firms that seem to have allowed them to boost significantly the efficiency of their worldwide operations.  Second, U.S. firms, on average, have more flexible and innovative business practices, sometimes called organizational capital, that a liberalized trade regime apparently allows them to transfer to their foreign operations.

Flexibility is most readily achieved by fostering an environment of maximum competition. A key element in creating this environment is flexible labor markets. Many working people equate labor market flexibility with job insecurity. Despite that perception, flexible labor policies appear to promote job creation. An increased capacity of management to discharge workers without excessive cost, for example, apparently increases companies' willingness to hire without fear of unremediable mistakes. The net effect, to the surprise of most, has been what appears to be a decline in the structural unemployment rate in the United States over the past quarter century.  Protectionism in all its guises, both domestic and international, does not contribute to the welfare of workers. At best, it is a short-term fix for a few workers at a cost of lower standards of living for a nation as a whole. Increased education and training for those displaced by creative destruction is the answer, not a stifling of competition.

A priority for national policy makers must be to resist policy proposals that would introduce rigidity into the economy and instead to press on every front for policies to make the economy even more flexible.

Being able to rely on markets to do the heavy lifting of adjustment is an exceptionally valuable policy asset. The impressive performance of the U.S. economy over the past couple of decades, despite shocks that in the past would have surely produced marked economic contraction, offers the clearest evidence of the benefits of increased market flexibility.

Most recently, the flexibility of our market-driven economy has allowed us, thus far, to weather reasonably well the steep rise in spot and futures prices for oil and natural gas that we have experienced over the past two years. The consequence has been a far more stable economy.

Flexibility is most readily achieved by fostering an environment of maximum competition.

[A] potential political cost of inflation targeting involves loss of flexibility...Specific goals for inflation are important, yes, but not under any and all circumstances. Real-world economies are subject to unanticipated shocks and unanticipated financial crises. Sometimes monetary authorities, even under inflation targeting, must respond to these shocks by going outside the price stability band for a short period.

An important reason that the U.S. economy is dynamic and productive, and generates a higher standard of living for us all, is that we embrace change. Now there will be people who suffer from such changes. But because these losses are part of the dynamic process that makes us all better off, society can and should help these people find their place in the new workforce.

Critics argue that while [the Fed] want[s] the public to believe inflation will remain well-anchored in the future, when the future finally rolls around, [it] might want the flexibility to pursue policies that are inconsistent with the earlier promise implied by an inflation target. In other words, [it] might find the commitment implied by [its] announced inflation target constraining. I would argue that this is a flexibility the Fed should be happy to do without.

In general, I would say flexibility, which is an extraordinarily valuable asset to the world financial system, is clearly advanced by having, essentially, a free floating rate system, which is largely what we have.

There is wide agreement about the necessity of some regulation to protect workers from illegal discrimination or employer fraud. There is less agreement, however, on the extent to which workplace regulations—including minimum wage laws, mandatory severance pay, right-to-work laws and legislated fringe benefits—are necessary. Overregulation of hiring, firing and working conditions can make the labor market too rigid and make businesses reluctant to start up and to hire workers.