You argue Alan Greenspan, Federal Reserve chairman, is getting it wrong and so is U.S. President George W. Bush. That is what some readers have written to say. But you don't say what the policy-makers should do. How should economic policy be run in the United States?
The response is no vote winner. It is an approach no politician would be likely to put forward —- and therein perhaps lies part of the problem. What an economist thinks should be done is often marked "dangerous" and kept away from the public. Don't mention this. People won't like it.
An exception: an economist-politician in Argentina, Ricardo López Murphy, who ran for president this year, having previously showed his unpopular characteristics a couple of years ago by advocating that workers' wages be cut in order to make Argentina more competitive. (In fact, devaluing, which Argentina eventually did, and not wage cuts, was the essential painful cure.) After so many deceptions, some voters did warm to López Murphy, but he has never won an election.
What are the unpopular policies that would return the U.S. economy to health as swiftly as possible?
In the first place, interest rate cuts, which Wall Street keeps clamoring for, are a mistake. The calls are based on simplistic reasoning: Growth is too low, therefore rates should be cut more. But have the rate cuts, which have taken the short-term Fed Funds rate down to 1.25 percent, provoked healthy growth? No. Have they worked in Japan? No. The medicine, the oft-repeated doses of rate-cutting medicine, has not got the U.S. economy going.
But medicine in overdose has side effects, and the side effects of too low interest rates are visible in the U.S. economy. The housing market is entering its fourth year of boom, with annual levels of house sales and house prices that were previously unprecedented. All this in an economy that is generally (and rightly) deemed to be weak. The housing boom is not in tune with the overall economy. Rather than being a reflection of strength in the economy, it is a counter-weight to weakness and a reflection of -- medicine designed to counter that weakness.
We ought to be worried. The housing boom emulates the stock market boom of the late 1990s. What will be the impact of falls in this market? The same as falls in the stock market. Houses that are worth less than the mortgages taken out on them will be a drag on household finances and on economic growth for years to come.
Our conclusion therefore is that Greenspan should not cut rates again while the housing market remains over-buoyant. The more Greenspan fuels inflation in house prices the worse will be the damage to the economy in the medium term and the longer it will take the United States to achieve healthy growth.
Should Greenspan raise rates? To do so now would bewilder everyone and provoke almost universal condemnation. Even now, this writer receives letters from readers who blame Greenspan for popping the wonderful 1990s stock market bubble by raising interest rates. But it is inevitable that bubbles burst. Not to let your economy rest on one is the key thing. If it does, one day a big let down will come.
So we would hold the short-term interest rate at its current towering level of 1.25 percent. And as the interest rate is the only real policy tool of the Fed, that leaves Greenspan out of the picture.
The other main policy tool in any economy is fiscal: government spending and taxes. Bush has his cards more or less on the table. His line is that he should be allowed to keep cutting taxes because the economy is weak and that Congress should stop trying to increase spending -- even though it is Bush's military and homeland defense budget that is soaring more than anything.
The overall result of Bush's approach on the budget is plain. In the current fiscal year (which began in October last year) the federal deficit is officially projected at a tad over $300 billion but seems more likely to come in the region of $400 billion -- a nominal sum that would be likely to take it to substantial level of over 3.5 percent of gross domestic product.
Will the deficit stop there? The cost of government programs such as Social Security and Medicare (medical care for the elderly) and Medicaid (medical help for those on low incomes) is projected to increase steadily in coming years. Government tax revenues will not pick up unless the economy does -- and we don't think it will. It therefore seems likely that the government's fiscal deficit will widen still further in 2004.
The danger this poses is that more and more issuance of government debt will push up the interest rates on longer-term debt even in the context of a weak, low inflation economy. This would mean that the government faces higher interest rates -- driving its deficit up further -- and that corporations and individuals face higher interest rates for their borrowing. The house price bubble would burst. The U.S. economy's mess would get worse and worse.
So what would our suggestion be? We think Bush should only cut taxes further if he can find correspondingly large ways of saving government spending. Isn't the idea that government deficit spending can get an economy going one that we ceased to believe a long time ago?
To tackle sickness you need the right medicine. It is crucial then, in our view, to acknowledge the role of the stock market bubble of the late 1990s in the U.S. economy's sickness and the fact that it was not just the stock market that went badly wrong. A consumer boom accompanied the stock bubble. As a result there is over-capacity now in not just U.S. but world manufacturing. The U.S. trade and current account deficits are signs of too much consumption by U.S. businesses and households, not too little. The extent of carpet-bagging and greed in the United States in the late 1990s was also staggering and perhaps unprecedented.
What all this has left is a weak economy that is struggling to walk and that two characters called Alan and George are trying to make run with the stick of cheap money and the carrot of tax cuts. Get running and consuming, you lazy donkey, they cry. To no avail.
What is the answer? The answer -- an unhappy and unacceptable one, we realize, for most readers, but true -- is that the best approach is to stop swigging medicine that doesn't work, or, to use our second metaphor, give the donkey a break.
Greenspan and Bush are doing everything possible to get the economy going. They should not be. Greenspan should have considered the future impact of house price inflation before cutting interest rates time and time again. Bush should be thinking about the fiscal deficit he is racking up and its future impact.
And what if they were to do (or to have done) less? What would be the result?
Recession. Yes, recession: that is what our policy recommendations would lead to. Sometimes it is not just inevitable, but necessary.
The recession of 2001 would have been much deeper and gone on longer. The housing boom would have been curbed. The stock market would be still lower. More Americans would now be out of a job. The dollar would have fallen sooner than it has done. The U.S. trade and current account deficits would have fallen faster. The whole world economy would now be weaker than it is.
And, painfully, the excesses of the 1990s would be being forced out of the U.S. economy. The economy would be closer to health, to a position from which it might grow healthily again.
After excess and imbalance, there is no painless cure, no elixir. Swigging again and again that bottle of cheap money quack medicine is just making the U.S. economy more and more unhealthy, and inviting not just recession but slump. The painful and honest cure would eventually prove the quicker one. Wasn't it always so?
(Global View is a weekly column in which our economics correspondent reflects on issues of importance for the global economy. Comments to [email protected].)
