The mechanics of the Wall Street model have been elucidated best by Alan Greenspan, chairman of the Federal Reserve Board. It all begins not with the demand of consumers and governments or with new technology, as in the Main Street model, but with what is now seen as the successful government-led war against inflation. As Greenspan testified before the joint Economic Committee of Congress in mid-1998, "The essential precondition for the emergence, and persistence, of this virtuous cycle is arguably the decline in the rate of inflation to near price stability"- which, in turn, provides the precondition for a stock market boom. 25

Wall Street's version of the virtuous cycle works something like what we see in Figure 1.2.[above] Bringing inflation under control allows interest rates to fall. This stimulates more capital investment, but most important, it provides a huge incentive for wealth holders to invest in equities. As financial portfolios appreciate, owners of stock feel wealthier. This leads to more discretionary spending- mostly by those of means, given their disproportionate ownership of stocks and mutual funds. increased spending then leads to expanded output, higher employment, and further investments in productivity-enhancing capital- more machines, more factories, and more office towers. In turn, more productive capital means higher corporate profits. Profits ratify the higher stock prices and send them even higher. And so it goes. In the process, Main Street gets a share of the growth as higher employment levels and higher productivity permit faster wage growth and rising family incomes.

What we earlier termed the Wall Street-Pennsylvania Avenue policy accord gets the credit for this wonderful turn of events. The most important element of the new accord was the balancing of the federal budget.

The White House and Congress committed themselves in principle and then in practice to bringing government spending into line with government revenue; having done this faster than expected, they then moved on to accruing a large budget surplus. This, according to the new conventional wisdom, would add to the national savings rate, reduce competition for consumption goods (thus reducing demand pressure on prices), and reduce competition for investment funds (by taking the government out of the borrowing business). This would help keep inflation under control, drive down long-term interest rates, and presumably stimulate growth.

But there was more to the anti-inflation aspect of the accord than budget balance. A second weapon in the war on inflation was a renewed and heightened commitment to free trade. This led to the passage of the North American Free Trade Agreement (NAFTA) with Canada and Mexico and a host of other bilateral and multilateral tariff reductions. While these trade agreements were enacted ostensibly to increase U.S. exports, their real objective was to keep downward pressure on wages and prices by spurring even more global competition.

Increasing the "flexibility" of labor markets became the third principle in the accord. Arguing that strong trade unions, periodic hikes in minimum wage laws, and overly generous welfare programs coddle labor and drive up wages, the accord frowned on any form of labor law reform that might help unions organize more workers. Minimum wages were increased, but by a trivial amount. Welfare reform focused on forcing millions of nonworking people into the paid labor force. Each of these policies may have been sold to the White House and Congress for different reasons, but the single underlying theme behind all of them was to encourage growth by increasing labor market "flexibility" and thereby curbing inflation.

Reinforcing all of this was the Federal Reserve's commitment to backstopping all efforts at holding the line on inflation. The Federal Reserve Board gained the confidence of Wall Street by demonstrating its vigilance at maintaining price stability, raising short-term interest rates in 1994 and again in 1995 as an inoculation against inflation. Since then, the Fed has practiced a more patient monetary policy, much to the credit of Chairman Greenspan. It has refrained from raising interest rates even as the unemployment rate came down below a level considered unsafe just a few years ago. Still, on numerous occasions the Fed has warned of impending inflationary pressure and has made it clear that interest rates would be raised at the slightest sign of upward movement in prices.

This new accord- based on balanced federal budgets, free trade, flexible labor markets, and a firm monetary policy- seems to have worked like a charm. As America continues to pull ahead of Europe in growth and employment, and as the once booming Asian economies struggle to regain their economic momentum, the wisdom of the Wall Street model is being acclaimed by an increasingly large and vocal chorus of economists, policymakers, pundits, and journalists, not only in the United States but also abroad. Prime Minister Tony Blair in England and Chancellor Gerhard Schroeder in Germany have taken on the mantle of Bill Clinton and embraced the Wall Street model. In Europe, it is now called "the Third Way" 26 As acceptance of the new paradigm grows, we are being cautioned that any deviation from its precepts or the government policies that support it could be fatal to continued prosperity Keeping Wall Street happy is not only a road to prosperity- it is now seen as the only road. All others are detours to economic stagnation.