J. Bradford DeLong
In the just-concluded first month, January 2001, of the real new millennium, economic policy has been turned topsy-turvy. The Treasury Secretary is acting like a Federal Reserve Chair, exalting the importance of monetary policy and interest rate changes and saying that the government's taxing and spending must play second fiddle. The Federal Reserve Chair seems most interested in the big Treasury problems of government debt and asset management rather than in what the equilibrium real rate of interest is, and whether the interest rates that the Federal Reserve sets should be higher or lower than the equilibrium rate. Think back two decades: back then it would have been inconceivable for a Treasury Secretary to give such a role to monetary policy, or for a Federal Reserve Chair to give such high importance to debt and asset management issues.
That economic policy has been turned topsy-turvy is a measure of just how much our economic policy world has changed over the past two decades. Our economic policy world has been changed by two things: first, the increasing confidence and skill of the Federal Reserve under Volcker and Greenspan at figuring out how to understand and manage the business cycle; second, the explosion of productivity growth generated by our new economy that means that current tax laws are projected to produce an absolute flood of government revenue over the next decade. It is not that people have changed their ideas as much as that the world has changed, and so how the old ideas apply has changed as well.
It was front-page news in January when Treasury Secretary Paul O'Neill said at his confirmation hearing that the administration's tax-cut plan was not a recession-fighting program. "I'm not going to make a huge case that [a tax cut] is the investment we need to make sure we don't go into a recession..." he said. His deviation from the party line was blasted by the conservative opinion sources that found him guilty of "subversion of the president-elect's agenda." How dare the Treasury Secretary say that fiscal policy--the taxing and spending of the federal government that the Treasury manages--was not an important recession-fighting measure!
It was also front-page news in January when Federal Reserve Chair Alan Greenspan called for tax cuts. In his standard hard-hitting Hemingwayesque prose, Chairman Greenspan said that "...recent data significantly raise the probability that sufficient resources will be available to undertake both debt reduction and surplus-lowering policy initiatives...", that the "time has come, in my judgement, to consider a budgetary strategy that is consistent with a preemptive smoothing of the glide path to zero federal debt or, more realistically, to the level of federal debt that is an effective irreducible minimum...", and that "...if long-term fiscal stability is the criterion, it is far better, in my judgment, that the surpluses be lowered by tax reductions...".
Or to put it a little more briefly, Alan Greenspan said: "Now it is time to start cutting taxes."
Why did he say this? Doesn't he believe that monetary policy is sufficient to manage the business cycle? What happened to Greenspan's long-run advocacy of budget surpluses because they "...hold down long-term real interest rates, thereby lowering the cost of capital and elevating private investment..."? It is as if the Treasury Secretary and the Federal Reserve Chair have switched places. The first now talks about the power of monetary policy. The second talks about how important it is that the government's tax collections not outstrip its spending plans.
Their apparent exchange of roles is an index of how much the changes of the past two decades--first the Federal Reserve's increasing grasp of how to conduct monetary policy, and second the explosion of productivity growth produced by the new economy--have changed our world. For if you listen carefully, you can see that both are making perfect sense.
Treasury Secretary Paul O'Neill is saying that fiscal policy--changes in tax laws and spending programs--has only a subordinate role to play in managing the business cycle, and that monetary policy--changes in interest rates--should play the leading role. Why? Because changes in tax laws and spending programs take much longer to be implemented and much longer to affect the economy. In the month of January Alan Greenspan's Federal Open Market Committee lowered interest rates by one percentage point, a policy move that economists' standard models say will stimulate the economy by as much as George W. Bush's entire proposed tax cut. And Greenpan's interest rate cuts will start to have their effect on the economy this calendar year. Tax cuts enacted this summer will not have material effects on the economy until the second half of next year at the earliest.
Paul O'Neill is right. As the officials of Britain's Treasury wrote to each other back when John Maynard Keynes first proposed using fiscal policy to manage the business cycle, "the one gilt-edged argument [against Keynes] is [the] delay" involved in using fiscal policy. Active fiscal policy has a role only when monetary policy is powerless--either because the central bank is focusing on stabilizing the value of the currency (as under a gold standard), or because it has already pushed interest rates as low as they can go and unemployment is still too high. If monetary policy can be used instead of fiscal policy, it should be used because fiscal policy takes too long to work. Do not shift more of your portfolio into cyclically-sensitive manufacturing stocks because you expect tax cuts to protect against the risk of a recession. That is one thing tax cuts cannot do.
Alan Greenspan is saying not that tax cuts are needed to fight an impending recession, but that it is time to start worrying about how to bring the long-run policy of deficit and debt reduction--started when President George H.W. Bush went against the wishes of Republican legislators like Newt Gingrich and Richard Armey and agreed to raise taxes and reform congressional budget procedures in 1990, and continued by President Clinton in 1993--to an end. Our current budget projections say that well before the end of this decade the federal debt will be paid back. If the government continues to run the surpluses the flood of revenue from current tax laws looks likely to produce when there is no more debt, the government will have to invest its surplus cash somewhere. The only logical place is in the U.S. private sector: the U.S. government will start buying up the bonds and shares of U.S. companies. This Alan Greenspan fears: he doesn't think that the U.S. government would be a very good shareholder of private enterprises.
And Alan Greenspan is right. There is no reason to think that the U.S. government would be very good as an investor in private enterprises. There was a time when the U.S. government owned a large stake in Chrysler, and everyone agrees that the Treasury staff worked hard to make that investment successful, but few would claim that experience should be the rule rather than the exception. Public bureaucracies are unlikely to be good at picking industries that need new cash, or at monitoring management. Driving the federal debt to zero makes sense. Driving the federal debt less than zero really does not.
There is the question of what kind of tax cuts the next decade should see. If we are to undertake tax cuts, it is important to think--as George W. Bush does not--about their consequences for the distribution of income. The past quarter century has seen America change itself from the middle-class distribution of income of the 1950s and 1960s to today's highly skewed, new Gilded Age distribution of income and wealth. Unless you think a society with a few rich vastly wealthier and economically more powerful than anybody else is a good society, the government should be--should over the past decade have been--using the tax code to moderate the upward leap in inequality that the U.S. has experienced. But it is safe to say that the idea that a society with a few rich and vastly wealthier than everyone else is not a good one has never entered George W. Bush's mind.
Moreover, should we have tax cuts at all? I would prefer a mix with fewer tax cuts and many, many more spending increases than Greenspan does. I think that there is a lot of room for the public sector to invest in America. We are a worse-off country because public sector investment has been systematically starved of funds over the past few decades. The proper balance between private and public investment--in research, in technology, in infrastructure, and in people--has much more public investment in it than our current federal budget allows.
Nevertheless, it is hard to disagree with Greenspan's position that--if our future economic growth is as bright as appears likely--it will be time by the middle of this decade to do something to drastically cut the government's surpluses. Just as it is hard to argue with O'Neill's position that a competent Federal Reserve is much better positioned to handle the business cycle than the Treasury.
As far as economic policy is concerned, it really is a new--and very different--millennium.
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