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| ECONOMIC TRANSITION | |
 December 19, 2000  |
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As President-elect Bush prepares to take office, the Fed signals that recession, not inflation, may be the biggest threat to the economy.
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Hugh Johnson, what do you see as the significance of today's Fed announcement? |
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| Understanding the Fed's action | |||||||||||||||||||||||||||||
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RAY SUAREZ: Amity Schlaes?
RAY SUAREZ: Diane Swonk, what do you read into the normally cryptic Fed?
RAY SUAREZ: Ruy Teixera?
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| The effects of a slowing economy | |||||||||||||||||||||||||||||
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RAY SUAREZ: Let's talk a little bit about the underlying economy though. Are there different groups of Americans who have different things at stake in a slowing economy?
RAY SUAREZ: Let's get a little bit more diagnostic statements on the state of the current economy. Diane Swonk, is it too soon to ring the alarm bells?
RAY SUAREZ: Amity Schlaes, I think you're the first person to have mentioned recession in this conversation? Are we really staring it in the face in 2001?
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| Debt reduction or tax cuts | |||||||||||||||||||||||||||||
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DIANE SWONK: Actually I would add to that, one of the moves that the Fed made today, Greenspan has made himself very clear on fiscal policy. His preference is debt reduction, not fiscal stimulus, either via tax cuts or spending increases. Debt reduction frees up money for the private sector and encourages productivity, growth and investment. That's Fed friendly stimulus. And I think today's move to some extent was a pre-emptive move to try to head off too much tax stimulus. RAY SUAREZ: Hugh Johnson, this was supposed to be what all the financial papers said was going to happen -- several straight quarters of not touching the interest rates, and it was going to slow down the economy. Now that it's slowing down, people are ringing their hands. What's going on?
RAY SUAREZ: So let's bring the political overlay into this. How does this affect the decision, near term, about how to introduce tax cuts into the political atmosphere -- a new President talking to a new Congress? HUGH JOHNSON: Well, if you're asking me, I would say that, you know, you couldn't have a better timing for all of this. I mean if you're going to have a slowdown in the economy and you want some response to it, you want to first of all have the resources to be able to cut taxes. And we have a big surplus. So you can cut taxes, and, of course, as I mentioned that the economy is slowing so the timing probably appropriate. There will probably be pretty big disagreement on the magnitude or size of that tax cut -- $1.3 trillion over ten years phased in, maybe that's a little large but the timing is probably appropriate for some sort of a stimulus package from the federal government in addition to the stimulus of lower short-term interest rates engineered by the Fed. RAY SUAREZ: And Ruy, that tax cut also will affect different people differently.
RAY SUAREZ: Amity Schlaes?
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| Searching for the right fiscal stimulus | |||||||||||||||||||||||||||||
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RAY SUAREZ: Diane Swonk, do you have to worry about inflation when you give....
RAY SUAREZ: Hugh Johnson? HUGH JOHNSON: Well, I think I'd just add to that again that it's really an art not a science. There's a lot of risk in policy, but the important point to me is that you've got leading indicators for the economy, indicators that tell us where we're going, not where we are that have been declining since January. We have leading indicators of inflation, again, telling us where inflation is going, not where it is. They've been declining saying inflation is not going to be a problem in the year 2001. The problem is going to be the economy. The Fed clearly sees that and is responding, in my judgment, in the exact right way. RAY SUAREZ: So, Ruy Teixera, to close with you, everybody, wherever they come on the wage ladder, has an interest in keeping the growth going? RUY TEIXERA: Oh, absolutely, absolutely. I mean, this has been -- the last five years have been the best five years in a generation, since the late '60s perhaps. Everybody wants to keep that going. Everybody wants to see those wage and income gains continue. So, the challenge for George Bush is to figure out a way to use the levers at his disposal. He has got to hope Alan Greenspan cooperates if rate cuts are needed. But he can't control Alan Greenspan; he has got to try to work with the Congress. How is he going to work with the Congress? Is he going to try to push his broad-base tax plan, which goes primarily to the well to do. Amity argues that's the best way to get the economy going. I think there are a lot of economists who might dissent from that. But he's got to work with Congress; he has to get Democrats and Republicans working together and he has to play to public opinion. And I think if you take all those factors into account, you want to look at a much smaller tax cut. You want to look at investing in things like education and health. I think that's how you could put together a stimulus package, if it's needed, that would be both - would be politically popular and would allow him to work together with both Democrats and Republicans in Congress. I think that's the way it needs to go. RAY SUAREZ: Panelists, thanks to you all. |
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RAY
SUAREZ: The presidential transition seems to be coming at a time of
economic transition. Today while leaving interest rates alone, the Federal
Reserve signaled a strong shift in its concerns, from inflation to a
slowing economy. A statement from the Fed cites, the drag on demand
and profits from rising energy costs, eroding consumer confidence, reports
of substantial shortfalls in sales and earnings, and stress in some
segments of the financial markets. The statement concludes that the
Fed consequently believes that the risks are weighted mainly toward
conditions that may generate economic weakness in the foreseeable future.
For a snapshot of the economy, as the nation undergoes political change,
I'm joined by Ruy Teixera, a political scientist with the Century Foundation,
a public policy research organization; Diane Swonk, chief economist
at Bank One Corporation; Amity Schlaes, a columnist with the Financial
Times and author of The Greedy Hand, Why Taxes Drive Americans
Crazy; and Hugh Johnson, chief investment officer at First Albany
Corporation. 
HUGH
JOHNSON: Well, I think the most important thing is that it obviously
signals that the Federal Reserve is not going to be sort of seduced
by somewhat higher inflation in keeping short-term interest rates too
high for too long, that they're going to respond to the slowdown that's
occurring in the U.S. economy by lowering short-term interest rates.
So, in some sense, I think today's move by the Federal Reserve, even
though it was a non-move where they didn't lower short-term interest
rates, is to simply signal to the financial markets and I think to business
people throughout the world that in time they will respond; my guess
is you'll see them lower short-term interest rates in January. So it's
a confidence-building move.
AMITY
SCHLAES: I agree with that. And you heard the president say the same
thing today. While the forecasts for growth have been pretty strong,
they're getting more and more negative as each day passes. It was 2
percent consensus last week. You hear a lot more people talking about
1 percent this week and a few people talking recession so it would be
a good move for the economy. But taxes are important too in this story
to help the economy. 
DIANE
SWONK: Well, I think this proves the Fed can turn on a dime. The Fed
has not moved on their interest rates even though they had an inflation
bias the last several of their meetings and it could mean they could
or not move on their next one. I do think an easing is very, very possible
in January although a year from now I think we might be discussing how
resilient the U.S. economy is and you can see the Fed do a 180-degree
turn-around again within the next 12 months. 
RUY
TEIXERA: Well, I think the problem for Bush is going to be is this going
to come too little too late? In other words, the Fed is signaling it's
willing to cut rates but if it doesn't cut rates for a while longer--
it's just signaling the willingness to do so should the situation arise--
is that going to wind up being too late to forestall a real recession
- because even if they cut rates today it wouldn't take effect for many,
many months. So now they're putting it farther down the road. And he
has got to worry that what happened to his father might eventually happen
to him. 
RUY
TEIXERA: Oh, absolutely. The Americans have the most to lose if the
economy slows down -- are the ones who really started gaining in the
last few years. If you look at the underlying wage and income data,
it's really the moderate income and non-college educated folks out there
who really have seen a good return in the last several years and have
started to catch back up some of the ground they've lost over many,
many years before that. Now, if the economy starts softening and the
growth slows, it's really going to hit these people the hardest, and
again to get back to George Bush's problem: That's politically where
he's going to have the most difficulties because in some ways it's those
people who put him into office. It's really non-college voters and moderate-income
voters among whom Bush was able to put together some fairly substantial
majorities. If they lose faith in him, that makes his task even more
difficult. 
DIANE
SWONK: Well, I think it's very appropriate for the Fed to be awake at
the wheel right now. I think there's an awful lot of noise in the information
we're getting right now though because of the indecision 2000 and the
presidential race. There's no question that took a toll on consumer
confidence. We've seen these effects before. Consumers often bounce
out of it fairly quickly. We also now are in the busiest days of the
Christmas season are actually the last days before Christmas and the
days immediately following Christmas, so the fat lady has far from sung
as far as this Christmas season as gone. And we know consumers have
shifted their spending away from what is counted in retail sales towards
services. We're buying back our free time for the first time; spending
on recreation, personal care, vacations, is up at a double-digit rate
from a year ago at least in our most recent data. And that has a real
lag on it. The Fed is going to have to watch that very closely and they'll
be watching the consumer very closely before their next meeting in January
when they make that next decision. 
AMITY
SCHLAES: Well, I don't yet believe so. But there was one negative we
didn't mention yet which was the oil price that's up there in -- around
30. That's just not where we were formerly. That is a negative if it
obtains and continues to obtain. No, I don't necessarily think recession
is around the corner, but I agree with Ruy, that you have to act now.
There's a lag to monetary policy, less so to tax policy, but there is
a lag. So you want to take action at this point. It's actually good
weather for tax cutting. It's good weather for what George W. Bush wants.
He's lucky in that regard. 
HUGH
JOHNSON: We wish this was more a science than an art. But monetary policy
is still unfortunately an art. Of course in addition to the rise in
interest rates engineered by the Federal Reserve, you had the unexpected
happen which, of course, was the sharp rise in oil prices this year.
So you superimpose higher short-term interest rates, higher energy prices
on an economy, which is still pretty leveraged, you know, we have a
lot of debt outstanding. Individuals are very heavily in debt. If you
do that you're going to get a slowdown in the economy and the dynamic
now is starting to change and it looks like a little more than a slowdown.
It looks like it's slowing down a little bit too rapidly or there's
the danger of a recession. 
RUY
TEIXERA: Oh, absolutely. The tax cuts will affect people very differently
and also the politics of different kinds of tax cuts are quite different.
If George Bush decides to keep on with his $1.3 trillion tax cut over
ten years, most of that goes to the well to do. That's a problem. Politically
it's a big problem. The Democrats are not going to be big enthusiasts
about moving forward with that kind of broad-based tax cut. And if you
look at where the public stands particularly the non-college moderate
to low income voters I'm talking about, their priorities aren't to have
a big tax cut. The data are very clear in this. They put a much higher
value on investing in education, investing in Social Security, in health
care, I mean if you want to stimulate the economy in a way that's going
to appeal to these voters, I think George Bush would be far better off
trying to put a substantial amount of money into education and health
and Social Security and so on, rather than spending it all on a big
tax cut. Though I realize it's a temptation for him because that's a
lot what the base of his own party wants him to do. But I think there
lies danger. He had better watch out.
AMITY
SCHLAES: Well, if you want to sometime late the economy that might appeal
to certain voters, yes, but if you want to stimulate the economy in
a way that's economically effective, at a time of potential downturn,
across the board rate cut plan like the one the President-elect has
is actually more effective because it allows this -- higher earners
who are the more productive members of society to create jobs and invest.
And this is not just a Republican idea. Democrats, many economists,
have gone along with it in history in other times. You want to recall,
for example, the '80s when we had a downturn and we did a supply-side
across the board rate cut similar but more radical to the one that we're
doing now because of economic trouble. And you, know, that's the tradition.
That's the way it's worked. When you have a downturn, you want to do
something that will make the productive end of society, the one that
gave us the tech boom this time, continue to be productive and competitive
particularly in the global context. What will keep America competitive
relative to Europe where the euro has gone up just now, at signs of
potential lagging in the states? What will keep the U.S. competitive
relative to Asia? And that's the sense of President-elect Bush's plan.
It's not illogical at all.
DIANE
SWONK: It's amazing in the course of just a few weeks everyone has thrown
inflation by the way side. One of the reasons the Federal Reserve is
willing to think about easing right now is that inflation, even though
it's accelerated, is still low. What we're talking about here is the
largest shift in fiscal stimulus in what still appears to be a very
full employment and accelerating wage economy. That's great, but it
is an economy that still has a ripeness for inflation if we get the
kind of stimulus on the fiscal side that's being talked about -- the
largest shift in fiscal stimulus since the Vietnam War. We know the
consequences of that. It was called the 1970s. You threw in oil prices
on top of it and it was not a pretty picture. So I think people are
being far too cavalier in how they think about policy right now, especially
the magnitude of tax cuts at these low levels of unemployment and what
is not yet even declared a soft landing let alone a hard landing.