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This past week Greenspan gave another interesting speech as he testified before the House Budget Committee. The chairman elaborated on the CBO's unified budget projections, recounting how a year ago the CBO was projecting a surplus as far as the eye could see and is now projecting deficits through fiscal 2005. A few of the statements he made during his testimony should not go unchallenged. For example, Greenspan takes the CBO projections at face value, as if this office has a stellar forecasting record — which it does not. The chairman also made the argument that the fiscal situation today remains much better than those of a decade ago, which is correct, but his explanation for the improvement in the fiscal situation is troubling. Greenspan stated,
While these factors did account for the improvement of the fiscal situation, they were not "external" to the economy. It turns out that the Soviets could not keep up with the U.S. and their economy collapsed, and the peace dividend that followed the Soviet Union's demise was the return on the SDI (or Star Wars) investment. More, the surge in productivity and rising stock market were not unrelated to the supply-side policy mix (including tax cuts) adopted by the Reagan administration. The combination of low inflation, low interest rates, lower taxation, and strong defense did wonders for the U.S. economy and its markets. The fact that Greenspan neglects to make the connection between the good economic fortunes of the 1990s and Reaganomics is disappointing. It reflects the static mentality of the chairman. He fails to make the inter-temporal connection between increased incentives and what happened a decade later. That is to say, the initial budget deficits caused by the Reagan-administration policies were essentially paid off during the good times that took place soon after. It's ironic that Greenspan fails to recognize the downstream benefits of Reaganomics, yet he is quick to attribute budget improvements to spending restraint. This is prima facie evidence of his static thinking. He only gives credit to static revenue gains and assumes as "external" any supply-side effect. And in taking this position he confirms what many of us knew all along. Alan Greenspan is no supply sider. The following excerpts from his speech confirm this conclusion:
The chairman argues that the budget rules worked better than he expected. He cites that between 1990 and 1998, discretionary spending fell from more than 10% of gross domestic product to less than 6.5 %. While those are the facts, he's wrong on the cause. The reason for the decline was largely due to an expansion of the base. In other words, the decline in the relative size of the government was due to the phenomenal growth that was born out of the policies adopted a decade earlier. How one solves a problem depends on how one frames the problem. It is fairly obvious that Alan Greenspan perceives the deficit to be a problem. In contrast the problem is profligate spending. Greenspan uses a static-type analysis where the long-term trends are independent of any behavioral change — such as those induced by tax rates. And he believes that contrary to the empirical evidence, budget deficits cause higher interest rates:
This Greenspan quote is disappointing in many ways. First, nominal returns are greatly influenced by the Fed — so why is he acquiescing? Monetary policy has a great deal to do with keeping interest rates low. His statement comes straight out of a Keynesian textbook. More, Greenspan's analysis implicitly assumes a closed economy. Hasn't he ever heard of capital flows financing capital investment? Where was he during the last two decades? Foreign capital flows financed a great deal of the U.S. growth. Another point of contention is Greenspan's Keynesian concept of savings. If viewed as a flow, savings are a residual — the difference between income and consumption and a net addition to wealth. During the good times, when the stock market and other assets are rising faster than expected, there is no need to save out of current income to add to wealth. In other words, during periods of rapid asset appreciation, there should only be low or small "savings" of current income. That's what happened during the last two decades. Looking back, America did pretty well. We grew fairly fast, had high productivity, low inflation, and were the world's growth engine. Not bad for a country with a "savings problem." A final bone of contention has to do with Greenspan's proposition that the deficit will crowd out private investment and lead to higher interest rates. But economist David Ricardo solved this argument several centuries ago. Ricardo argued that government borrowing constituted future tax liabilities and that a forward-looking economy would anticipate future taxes and set-aside monies to pay for those future taxes. The empirical evidence does not seem to be too kind to Greenspan's crowding-out myth — nor any of his other emerging myths. |
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lan Greenspan never ceases to amaze. A few weeks back he made the argument
that the Fed was impotent to prevent the stock-market bubble of the 1990s
— the implication being that the Fed could do little to help during
the aftermath. 
