From March 1991 through March 2001, the US economy experienced the longest expansion in its history. During the latter half of the expansion, from about 1995 through 2001, the combination of rapid output growth, low unemployment and low inflation led some to suggest that the economy had entered a new era or New Economy, and that many of the old rules of thumb that guided monetary policy in the past no longer applied. Subsequent developments pointed out the folly of some of the more extravagant claims that were made at the height of the boom, but there is now abundant evidence that the substance of the New Economy was driven by a pickup in trend productivity growth.
This paper reviews some of the challenges monetary policy makers faced in discerning this change in trend, the factors that drove it and how New Economy thinking worked its way into the deliberations of the Federal Open Market Committee. The paper concludes with a preliminary examination of the recession that began in March 2001 and discusses how the response of monetary policy to the slowdown in activity was influenced by New Economy thinking.