THINKING THINGS OVER
The Economy: Do No Harm
So the economy doesn't rise and fall at Greenspan's command.
BY ROBERT L. BARTLEY
Monday, August 11, 2003 12:01 a.m. EDT
A tide of favorable economic indicators--surging productivity, falling unemployment claims, hefty retail sales--has engulfed the interest-rate dither that preoccupied market oracles only a week ago. Look here for some lessons about how economies grow.
For openers, the U.S. economy does not rise and set with Alan Greenspan. If you believe what you've read in recent years, the Fed chairman sits in his palace on Constitution Avenue conducting the economy with a magic baton. It now turns out that Greenspan & Co. can't even control interest rates, let alone the whole economy.
When the Fed cut its target rate for overnight deposits to 1.0% from 1.25%, the bond market went the other way, boosting long-term rates. And of course, long rates, not overnight ones, matter in the economy. Low mortgage rates sparked the refinancing that has allowed consumers to keep the economy afloat. In theory, low long-term rates should also help business investment, but they haven't, in the face of uncertainties introduced by Osama bin Laden, Saddam Hussein and the nine Democratic dwarves.
With the oracles certain to re-emerge after the Fed's Open Market Committee meeting tomorrow, it's worth pausing to note some dry-behind-the-ears wisdom. First, as we've just seen, the Fed can maybe control an interest rate, but no way can it control the yield curve--all interest rates for different maturities.
The recent kerfuffle over "unconventional" monetary-policy measures, second, is an old story. To translate the jargon: Conventional measures mean buying fed funds, or overnight deposits, in the hope that this will influence long rates further out on the yield curve. "Unconventional" measures would mean buying long-term Treasury bonds directly, on the theory that this would have a stronger impact on long-term rates.
This revives the "bills-only" debate from the darkest 1950s. The bills-only doctrine held that the Fed should deal in bills, short-term, but not in bonds, long-term. The bills-only folks felt the long-term market would do better without government meddling, and this became the "conventional" position.
Except, that is, for "operation twist" in 1961, when the economy was recovering from recession but the balance of payments was troublesome. Treasury Undersecretary Robert Roosa had the brainstorm that the economy depended on long rates but the balance of payments depended on short rates, or "hot money." So he tried to twist the yield curve by selling bills while buying bonds. He got long rates down to 3.73% from 3.89%, but then they went back up to 4.06%.
Then as now, long-term rates have a tendency to ignore the Fed's baton and march to their own drummer. In recent years (see chart) they've been on a generally declining trend. Some of the peaks and valleys along the way correspond to periods of Fed easing and tightening, but it's hard to tell whether the Fed is leading the market or following it. The general decline, too, has proceeded irrespective of government budget surpluses and deficits, actual and projected.
Rates can't drop forever, however, and the recent jump to 4% or so looks more like a return to normal than an argument for bringing back operation twist. Indeed, the decade-long fall in long rates no doubt mostly reflects declining inflation expectations. We now have inflation-adjusted bonds, and their yields have also jumped in the last few weeks. This suggests we're seeing an increase not in inflation premiums but in the real rate of interest. This would be a sign of a recovering economy.
On the fiscal side, too, stimulus is already nicely in place. The 2003 Bush tax cut took the essential step of immediately implementing the marginal rate cuts passed in 2001; these had been phased in through 2006, actually creating an incentive to defer realization of income. The cuts in the taxation of dividends and capital gains also should spur investment and improve corporate capital structures. We're indeed seeing the first signs of a pick-up in business investment.
The main negative at the moment is the uncertainty introduced by the Democratic primary contest. Democrats used to believe in Keynes, who prescribed deficits during recessions. But following some mysterious muse instead, today's Democratic candidates are debating over how much to raise taxes. Also, how severely to curtail free trade. Howard Dean has offered an economic program of a higher minimum wage, expanded unemployment insurance, federal payments to state and local government and so on. This is not an economic program, it's a special-interest shopping list.
Happily, the economy has a natural tendency to grow. It's been doing so, with ups and downs, since the cavemen discovered fire. Recessions tend naturally to produce recoveries. Job creation is often the last to recover, especially given the recent and ongoing surge in productivity. But this same surge is a positive.
World economic growth picked up sharply around 1820, reflecting the industrial revolution. We're right now in another period of unusual technological innovation. The big story in the late 1800s was the development of the North American continent; right now we're embarked on a similar adventure, incorporating a billion Chinese into the modern world economy. This is a powerful force for creating wealth, and also for putting a lid on inflationary pressures.
Prospects are favorable, in short, for both cyclical recovery and secular growth. The main task for presidents, congresspeople and central bankers is to stay out of the way.
Mr. Bartley is editor emeritus of The Wall Street Journal. His column appears Mondays in the Journal and on OpinionJournal.com.
URL:http://www.opinionjournal.com/columnists/rbartley/?id=110003871 |
