Hard Times, Hard Choices


When circumstances change, some opinions have to change too: On that point, at least, we entirely concur with Keynes. For most of 2007 and half of 2008, we urged the Fed first to stop easing monetary policy and then to tighten it. Excessively accommodative Fed policy was storing up future trouble by generating present bubbles and future inflation. But the financial crisis this fall generated special circumstances. The velocity of money appears to have dropped sharply (or, if you prefer, the demand for cash appears to have risen sharply), and a dramatic further easing was therefore warranted.

That easing may, however, already have gone too far. Even if it has not, it should be temporary: Liquidity should be withdrawn as soon as velocity begins to gather. The Fed should not wait for a lagging indicator such as unemployment to drop before taking that step, even if tightening is unpopular with political Washington. Inflation is dormant, not dead; the “slingshot” scenario, in which the economy endures a brief deflation before a bout of inflation, should weigh heavily on the Fed’s governors.

Under normal circumstances, we would not look favorably on the proposals now being made by some conservative economists to have the federal government encourage the refinancing of mortgages at lower interest rates. It is attractive today not so much because it would put a floor under housing prices but because it would eat up some mortgage-backed securities while making it easier to price the risk on those that would remain.

Congress and the executive branch (pre- and post-inaugural) can also contribute to getting the economy back on the growth track — and, more important, raising the economy’s long-term trend growth — by making tax and regulatory reforms. The “two-fleet rule” on automotive fuel economy serves no purpose but to make Detroit more inefficient. Now is an excellent time to scrap it. The inflexible application of mark-to-market accounting rules continues to have perverse effects. It should be relaxed, particularly when determining whether financial institutions are meeting their capital requirements.

We prefer permanent to temporary tax relief, so as to promote stability and to reduce the incentive for people to shift the timing of their economic activity. But if Congress cannot resist enacting another “stimulus” — and it probably cannot — it is far better that it take the form of a temporary reduction in the corporate tax rate and the payroll tax rate than that of new federal spending. Such temporary tax cuts would probably buoy the markets and increase consumer confidence; they would almost surely create or save jobs, to borrow the president-elect’s formulation. Expanding the child tax credit, as House Republican leader John Boehner has proposed, would put money in parents’ pockets, soften the blow of the recession, and go some distance toward reducing the tax code’s bias against families.

Rahm Emanuel has notoriously said that no crisis should go to waste. Better, we think, for politicians to keep their heads and help this crisis pass.


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