The patient is ailing, even after plenty of medicine. What should we do? The committee of doctors met Tuesday and Wednesday in Washington and decided that the only thing for it was more medicine, another big dose, which would surely be enough. Was their decision the right one?
Chief doctor Alan, also known as U.S. Federal Reserve Chairman Greenspan, is a man for bold action that perhaps belies his venerable visage. But he might be said, too, to be a man driven by fear: that the patient will die on his watch.
Let us return briefly to a United Press International interview with the Nobel Prize-winning economist, Milton Friedman, over a year ago. "What I think is on Alan's mind," Friedman said, "is that there have been only two periods of history like the current one in which both growth and the stock market rushed ahead for a decade. The first was the United States in the 1930s; the second Japan in the 1980s. Both ended in disaster."
Friedman had another interesting comment. It was that, in his view, it was after the bursting of the respective bubbles that monetary policy went wrong. Policy was not accommodative enough and as a result both economies, the U.S. one in the 1930s and the Japanese one in the 1990s, spiraled down. Therefore, Friedman thought that what Greenspan was doing (and is still doing now) is essentially correct. The key thing is to stimulate the economy and prevent the downward spiral.
There was no mention, of course, of a downward spiral in the statement issued Tuesday by the Federal Reserve's Open Market Committee. Instead it referred to the need to provide an accommodative stance "as the economy works its way through this current soft spot."
And it suggested that no more medicine should be needed for too much medicine might ignite inflation and in future "the risks are balanced."
But what is the cause of the "soft spot?" What is it that ails the patient?
The FOMC's statement referred to "greater uncertainty, in part attributable to heightened geopolitical risks;" in other words, the possibility of war with Iraq, which certainly depressed the U.S. stock market in September though its mood has improved since as U.S. President George W. Bush struggles to gain U.N. backing for a strike.
But what we must ask is whether it is just "uncertainty" that "is currently inhibiting spending, production, and employment," or is there something more besides? In other words, is Dr. Alan's diagnosis correct?
This correspondent continues to doubt it. There is more wrong with the U.S. economy than some geo-political uncertainty. Why are the U.S. trade and current account deficits so high? Why are personal saving rates so low? Why have interest rates as low as 1.75 percent -- unimaginably low seen from just two years ago -- been unable to get the patient on his feet?
The problem, and Dr. Alan probably realizes it, even if he is discreet in public, is that the patient became profoundly sick under his care and Dr. Alan did not recognize it at the time or, if he did recognize it, did not treat it effectively. Now that the patient is very sick, unusually sick, as a result of a rare complaint called "asset price bubble," the right treatment is not so easy to prescribe.
The U.S. stock market boom distorted the economy. Cisco became the United States' biggest company by market capitalization. Investors invested too much. Consumers consumed too much. Only government saved, by running fiscal surpluses, but now the government, too, is in deficit, and yet companies and consumers continue to run on debt.
The question is what is the treatment for all this? If we say that the world's biggest economy overdid it in those exuberant days of the 1990s, what is Dr. Alan to do about it now?
His remedy might be said to be working. Thanks to all those interest rate cuts, the recession of 2001 was a mini one and the economy has been growing this year, even if, judged by employment, it seems not to be. But at the same time, the trade and current account deficits have not corrected and the fiscal deficit is growing worse and house prices, encouraged by low interest rates, are emulating the bubble that occurred previously in stocks. Might that not do more damage in time to come?
Yes, Dr. Alan has had to treat the patient with rate cuts. But are more and more doses of the medicine the right answer? Is there not a danger that too much medicine will have dangerous side effects, such as soaring house prices?
Sometimes it is time that a patient needs. The sickness must work its way out of the system. Too much medicine is itself a poison. The doctor makes a mistake if he tries to do too much. Dr. Alan might have done better to have held back Tuesday on his medicine. He and the patient might need it later.
Comments to email@example.com