"It is a pleasure once again to speak before the National Italian American Foundation. I have long since been awarded the status of honorary Italian, for which I am sincerely appreciative.

In my more than eighteen years at the Federal Reserve, much has surprised me, but nothing more than the remarkable ability of our economy to absorb and recover from the shocks of stock market crashes, credit crunches, terrorism, and hurricanes--blows that would have almost certainly precipitated deep recessions in decades past. This resilience, not evident except in retrospect, owes to a remarkable increase in economic flexibility, partly the consequence of deliberate economic policy and partly the consequence of innovations in information technology.

A couple of weeks ago, I outlined to a convention of fellow economists how I believe this all came about. I should like to share some of those views with you this morning.

For this country's first century and a half, government was only peripherally engaged in what we currently term the management of aggregate demand. Any endeavor to alter the path of private economic activity through active intervention would have been deemed inappropriate and, more important, unnecessary. In one of the more notable coincidences of history, our Declaration of Independence was signed the same year in which Adam Smith published his Wealth of Nations. Smith's prescription of letting markets prevail with minimal governmental interference became the guiding philosophy of American leadership for much of our history.

With a masterful insight into the workings of the free-market institutions that were then emerging, Smith postulated an "invisible hand" in which competitive behavior drove an economy's resources toward their fullest and most efficient use. Economic growth and prosperity, he argued, would emerge if governments stood aside and allowed markets to work.

Indeed, within a very few decades, free-market capitalism became the prevailing stance of most governments' economic policy, even if it was often implemented imperfectly. This framework withstood the conceptual onslaughts of Robert Owen's utopians, Karl Marx's communists and later, the Fabian socialists.

The free-market paradigm came under more-vigorous attack after the collapse of the world's major economies in the 1930s. As the global depression deepened, the seeming failure of competitive markets to restore full employment perplexed economists until John Maynard Keynes offered an explanation that was to influence policy practitioners for generations to come. He argued that, contrary to the tenets of Smith and his followers, market systems did not always converge to full employment. They often appeared to settle at an equilibrium in which significant segments of the workforce were unable to find jobs. In the place of Smith's laissez-faire approach arose the view that government action was required to restore full employment and to rectify what were seen as other deficiencies of market-driven outcomes.

A tidal wave of regulation soon swept over much of the American business community. Labor relations, securities markets, banking, agricultural pricing, and many other segments of the U.S. economy became subject to the oversight of government.

The apparent success of the economy during World War II, which operated at full employment in contrast to the earlier frightening developments during the Depression years, led to a considerable reluctance to fully dismantle wartime regulations when the hostilities came to an end.

However, cracks in the facade of government economic management appeared early in the post-World War II years, and those cracks continued to widen as time passed. At the macro level, the system of wage and price controls imposed in the 1970s to deal with the problem of inflation proved unworkable and ineffective. And at the micro level, heavy regulation of many industries was increasingly seen as impeding efficiency and competitiveness. By the early 1980s, the long-prevalent notion that the centrally planned economy of the Soviet Union was catching up with the West had begun to be discredited, though it was not fully discarded until the collapse of the Berlin Wall in 1989 exposed the economic ruin behind the Iron Curtain.

Starting in the 1970s, U.S. Presidents, supported by bipartisan majorities in the Congress, responded to the growing recognition of the distortions created by regulation, by deregulating large segments of the transportation, communications, energy, and financial services industries. The stated purpose of this deregulation was to enhance competition, which had come to be seen as a significant spur to productivity growth and elevated standards of living. Assisting in the dismantling of economic restraints was the persistent, albeit slow, lowering of barriers to cross-border trade and finance.

As a consequence, the United States, then widely seen as a once-great economic power that had lost its way, gradually moved back to the forefront of what Joseph Schumpeter, the renowned Harvard professor, had called "creative destruction"--the continual scrapping of old technologies to make way for the innovative. In that paradigm, standards of living rise because depreciation and other cash flows of industries employing older, increasingly obsolescent technologies are marshaled, along with new savings, to finance the production of capital assets that almost always embody cutting-edge technologies. Workers, of necessity, migrate with the capital.

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