Fed chairman Alan Greenspan is upbeat and confident about the short-term prospects for economic recovery.
As you know, the U.S. economy appears to have made the transition from a period of subpar growth to one of more vigorous expansion. Real gross domestic product (GDP) rose briskly in the second half of last year, fueled by a sizable increase in household spending, a notable strengthening in business investment, and a sharp rebound in exports. Moreover, productivity surged, prices remained stable, and financial conditions improved further. Overall, the economy has lately made impressive gains in output and real incomes, although progress in creating jobs has been limited.The most recent indicators suggest that the economy is off to a strong start in 2004, and prospects for sustaining the expansion in the period ahead are good. The marked improvement in the financial situations of many households and businesses in recent years should bolster aggregate demand. And with short-term real interest rates close to zero, monetary policy remains highly accommodative. Also, the impetus from fiscal policy appears likely to stay expansionary through this year. At the same time, increases in efficiency and a significant level of underutilized resources should help keep a lid on inflation.
However, he's quite worried about the deficits, especially because they are caused by the enormous increases in government spending that started in the 1990s, a trend that started under Bill Clinton and has, unfortunately, continued under George W. Bush.
For a time, the fiscal stimulus associated with the larger deficits was helpful in shoring up a weak economy. During the next few years, these deficits will tend to narrow somewhat as the economic expansion proceeds and rising incomes generate increases in revenues. Moreover, the current ramp-up in defense spending will not continue indefinitely. Merely maintaining a given military commitment, rather than adding to it, will remove an important factor driving the deficit higher. But the ratio of federal debt held by the public to GDP has already stopped falling and has even edged up in the past couple of years--implying a worsening of the starting point from which policymakers will have to address the adverse budgetary implications of an aging population and rising health care costs.For about a decade, the rules laid out in the Budget Enforcement Act of 1990, and the later modifications and extensions of the act, provided a procedural framework that helped the Congress make the difficult decisions that were required to forge a better fiscal balance. However, the brief emergence of surpluses eroded the will to adhere to those rules, and many of the provisions that helped to restrain budgetary decisionmaking in the 1990s--in particular, the limits on discretionary spending and the PAYGO requirements--were violated more and more frequently and eventually allowed to expire. In recent years, budget debates have turned to choices offered by those advocating tax cuts and those advocating increased spending. To date, actions that would lower forthcoming deficits have received only narrow support, and many analysts are becoming increasingly concerned that, without a restoration of the budget enforcement mechanisms and the fundamental political will they signal, the inbuilt political bias in favor of red ink will once again become entrenched.
In view of this upward ratchet in government programs and the enormous uncertainty about the upper bounds of future demands for medical care, I believe that a thorough review of our spending commitments--and at least some adjustment in those commitments--is necessary for prudent policy. I also believe that we have an obligation to those in and near retirement to honor what has been promised to them. If changes need to be made, they should be made soon enough so that future retirees have time to adjust their plans for retirement spending and to make sure that their personal resources, along with what they expect to receive from the government, will be sufficient to meet their retirement needs.
Wisely, Greenspan is also wary of using the deficits as an excuse to raise taxes -- not when spending is the problem.
I certainly agree that the same scrutiny needs to be applied to taxes. However, tax rate increases of sufficient dimension to deal with our looming fiscal problems arguably pose significant risks to economic growth and the revenue base. The exact magnitude of such risks is very difficult to estimate, but they are of enough concern, in my judgment, to warrant aiming to close the fiscal gap primarily, if not wholly, from the outlay side.Posted by Alan at February 25, 2004 05:15 PMVia the Federal Reserve