Kudlow: Why Delay an Ease?
By Lawrence Kudlow
Contributing Editor
Mar 1, 2001 04:15 PM
In the political game of expectations this past week, George Bush's quasi State of the Union message on tax and budget
policy passed with flying colors. But Alan Greenspan flunked in his monetary report to Congress.
President Bush steadfastly and artfully defended his pro-growth tax-rate relief plan, along with a flexible freeze budget
and a move to ease energy drilling and production rules in order to generate more power for the high-tech wired economy.
In sum, Bush put forward a clear economic growth strategy to reverse the Clinton economic decline he has inherited.
Mr. Greenspan, however, had no such message. After considerable speculation that the Fed chairman would significantly
revise the economic report he delivered two weeks ago to the Senate, and great market hopes of a 50 basis-point
inter-meeting rate cut, the so-called maestro vetoed the early rate cut idea and altered his testimony only slightly, but
pessimistically.
In response, stock markets fell again. And again. The bear market Nasdaq technology index, already down more than 50
percent from its peak, is now joined by the S&P 500, which has recently moved into the official bear territory of a 20
percent decline.
The stock market message is a recessionary one. And Mr. Greenspan said very little to rebut this outcome. He no longer
disputes that the sizable drop in consumer confidence is consistent with past recessions. He also believes that "excesses
built up in 1999 and early 2000" are still causing a "retrenchment" in the economy.
Reading between the lines, Greenspanspeak is essentially saying that a recession is upon us, and there's really not much
the Fed can do about it. Yes, the central bank will cut interest rates more in the months ahead. But they prefer to do so at
regularly scheduled FOMC meetings, rather than in between meetings.
The next Fed policy get-together is March 20, with future meetings scheduled for May 15 and June 27. It is not
unreasonable to anticipate 50- basis point cuts in the fed funds policy rate at each of these meetings. That would bring the
key rate to 4 percent by mid-year.
However, there is a cost to delaying these rate cuts. Think of it this way. If you know there's a deep discount car sale
starting one week from now, will you shop for a new auto this coming week? Or will you wait to capture the price-cut
benefits of the official sale?
The same holds true for the economy. Since everyone in our well-informed web site economy knows that future fed rate
cuts are in the cards, they are likely to hold back on spending and investing actions until the Fed actually pulls the trigger.
Hence delayed interest rate cuts will actually have the unwanted effect of delaying economic recovery. The Fed may
believe it is acting prudently in an orderly manner by holding back until its formal policy meetings occur, but the unintended
consequence of this thinking will cause a lengthier downturn in the short run.
The exact same principle holds for tax policy. That is why President Bush has wisely asked Congress for a retroactive
tax-rate cut and prompt legislative action to trigger it. Delaying or phasing in tax cuts will slow the economy in the short run.
This is particularly the case for upper end earners, who supply much of the risk capital for new business investment. Why
declare a transaction when the top rate is 40 percent, when you know in a year or two (or six) it might be 33 percent? Risk
capital will be withheld until investors can capture the lowest marginal tax-rate. But it's the provision of risk capital that truly
drives the animal spirits of growth.
Back to Mr. Greenspan. He continues to avoid any responsibility for the economic downturn. Instead, he puts the finger on
mistake-prone business people who accumulated too many inventories, or crazed technology entrepreneurs who
committed too much capital, or overly exuberant stock market investors, or nasty OPEC countries who jacked up oil prices.
Everyone's to blame but the Fed. But how about the inverted Treasury yield curve most of last year, which was signaling
excess Fed tightening and warning of a future recession? How about the wild go-and-stop money supply policy, where
12-month monetary base growth swung from 6.6 percent in December 1998 to 16 percent in December 1999, and then
collapsed to negative 2.5 percent by December 2000.
Even today, the central bank refuses to acknowledge that virtually every commodity price on the planet is deflating. Or that
the short end of the Treasury curve is still inverted, where three-month Treasury bills yield more than two- and five-year
Treasury notes.
These commodity and financial price indicators suggest that
liquidity preferences in the economy are very high (retail
and institutional money funds are growing like topsy), but
the Fed's provision of liquidity is still in short supply.
Economic growth is not likely to resume until liquidity is
adequate and the Treasury curve is upward sloping from
the short end all the way out to the longest dated maturities.
Commodity prices and interest rates will have to stabilize
before confidence returns.
Easier money and lower tax-rates is an appropriate
monetary-fiscal policy mix to stimulate recovery. And help is on the way. But it now looks like delaying tactics from the Fed
will postpone a likely stock market and economic rebound for several more months. |
