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A Seismic Shift
There are big changes in store for the economy.


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Larry Kudlow

Some big events this past week — including the Republican sweep of Congress, massive easing by the Federal Reserve, and new word that Americans are producing at remarkable levels — may together represent a seismic shift in the economic landscape.

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The Fed lowered the target interest rate to 1.25% last week, which was fine in itself. But the action was made sweeter by the announcement that accompanied it: The Federal Reserve “continues to believe that an accommodative stance of monetary policy, coupled with still-robust underlying growth in productivity, is providing important ongoing support to economic activity.”

The crucial reference to productivity suggests that the old Alan Greenspan is back. In the late 1990s the Fed chairman consistently — and correctly — argued that rapid productivity gains were increasing the economy’s potential to grow. Therefore, the Fed could afford to be more generous with the cash without being concerned about inflation. At the time, the country’s productivity spike amounted to a supply-side tax cut that was helped along by more cash from the central bank.

Why Greenspan departed from this script in 2000 is one of the great mysteries of monetary history. For about eighteen months, into the middle of 2001, the estimable Fed chairman worried that too-high stock prices and too-strong economic growth were reviving inflation. So, rather than keeping the economy’s money-pump primed, he deflated the money supply, all while ignoring clear recessionary signals.

Of course, the bubble theorists put the technology sector high on the list of what caused the recession. But while tech stocks fell dramatically, the economic benefits of tech kept circulating through the economy. Consequently, all through the recent dismal period, America’s output-per-hour jumped, with productivity increasing 5.3% over the past four quarters. That’s yet another reminder of what economist Joseph Schumpeter called gales of creative destruction. And it reminds us of just how strong the American economy can be — provided that the Fed doesn’t go cheap with the money supply.

But last week’s Fed action suggests that the high priests of the monetary temple have returned to a truly growth-oriented policy. Finally. The economy, as measured by GDP, is not growing as fast as productivity. Because of that, business prices are falling and jobs are being cut. But if the Fed stays loose with the money over the next year, this economy will be able to grow at the speed that it wants to grow — which is fast.

This past week delivered another positive for the economy in the form of a strong mid-term election mandate for the White House. In January, President Bush is expected to include across-the-board tax cuts in his 2003 budget. His recipe may include tax cuts on dividends, business write-offs for the purchase of new equipment, higher limits for supersaver accounts, investment losses, and gains, and faster implementation of last year’s personal tax cuts.

Inside the White House it is expected that economist Glenn Hubbard will be given new responsibilities to shepherd along such a big-bang economic growth package. In the Senate, Don Nickles of Oklahoma will likely become the chairman of the Senate Budget Committee, where he can lead a massive budget reconciliation act. And over at the Federal Reserve, the recent decision to link productivity with monetary policy strongly suggests that Dallas Fed president Robert McTeer is being groomed to succeed Greenspan in 2004 when his term ends — or perhaps sooner should the chairman decide to take early retirement.

McTeer is an apostle of the high-tech new economy, where spillovers from technological innovation continue to revolutionize the old economy. He will pair wonderfully with Hubbard in the White House. A McTeer-Hubbard combination will generate a pro-growth policy mix that can dominate the economic landscape for years to come.

With this lineup coming together, the only policymaking sore spot is over at the Securities and Exchange Commission. As it looks now, there’s a possibility that Treasury undersecretary Peter Fisher could fill the spot recently vacated by the embattled Harvey Pitt. The former New York Fed executive strongly believes in full disclosure and transparency for corporate accounting and governance, as well as the inherent disciplinary rigors of the marketplace. Fisher could be just the right person to restore investor confidence while at the same time avoiding the pitfalls of over-regulation.

In other words, there are big changes in store for the economy. President George W. Bush will use a fresh new voter mandate to take full command of the economy with far-reaching reforms that will dominate the fiscal scene for years to come. The voters have given him their trust, and he will not wait long to put powerful growth measures back into action.



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