The Republican House passed its stimulus package soon after 9/11, and it was filled with good economic sense. It would have eliminated the alternative minimum tax for large and small businesses, lowered the capital-gains tax, accelerated part of the income-tax-cut phase-in, and provided a three-year cash-expensing bonus for the depreciation of equipment.
But the argument against the plan was that it was too costly in budget-deficit terms and hence it would drive up interest rates. So the stimulus proposal died, and interest rates went up anyway.
Here’s a gauge of the interest-rate surge: In the U.S. government securities market, the curve from two years out to ten years has increased by about 100 basis points since early November. This upward rate shift began that very same month when the central bank lowered the federal funds rate for the tenth time in a year to 2% from 2.5%.
Since then, the central bank dropped its target to 1.75% — yet Treasury rates remain up. So it’s clear that Fed policy influences interest rates. And the fact that most Treasury market rates have risen while the Fed’s policy rate has declined is an important signal. It is telling the central bank that they have done enough in the way of providing stimulus.
Actually, if Congress had permanently reduced tax rates on personal and business income, then Treasury rates may very well have declined. Tax cuts that stimulate business investment and individual hours worked increase the economy’s potential to grow. More goods chasing the same quantity of money reduces inflation expectations and interest rates.
But the failure of Washington to generate a growth-oriented tax-cut package suggested to market investors that more money created by the Fed would be a negative. This is supply-side logic, and it runs counter to Washington’s deficit-mania. But the proof is in the pudding, and the Treasury curve doesn’t lie.
For these and other reasons there is no need for Greenspan & Co. to ease rates again at this Wednesday’s Fed meeting. Medium and long-term Treasury rates are already in revolt against additional Fed loosening. Meanwhile, the basic money supply controlled by the bank (the monetary base) is surging. Since the middle of last year, money growth is running at a 13.7% annual rate, with most of the new-money creation coming since 9/11. Belatedly, the Fed has finally done its job to reverse the recessionary deflation it put in place in 2000 (when they raised rates feverishly through the year). Their money-creating job is now complete. They shouldn’t overstay their easier-money welcome.
Other market-based indicators paint the same picture. Commodity indexes, including gold, have stabilized. King dollar steadily sits on its throne. The so-called “liquidity spread” between two-year Treasuries and the overnight fed funds rate has widened to 140 basis point — a signal of strong monetary stimulus.
Keynesian fine-tuning of both fiscal and monetary policy is counter-productive. The less the Fed tinkers, the stronger the economy will be. And the more transfer payments from Uncle Sam — which includes temporary tax cuts — the weaker the economy will be. In the absence of permanent tax reform to flatten rates and simplify the tax base, Congress is better off doing nothing right now.
Years ago as a young pup working for President Reagan I remember chief economist Murray Weidenbaum counseling the cabinet that sometimes it’s better to just stand there and do nothing. If Murray were in government today, I’ll bet that’s what he would advise. And he would be right.
To strengthen the outlook for economic recovery, government should do nothing right now. And Alan Greenspan should lock his hands behind his back.