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Clinton’s Opportunity

President-elect Clinton faces a situation in which US economic policy and the US economy have reached a standoff. Business is sluggish in part because it must carry the weight of past mistakes, both public and private, but also in part because it has been receiving little help from what in other circumstances would be standard policies used by the federal government to stimulate the economy. At the same time, such policy measures have been largely absent because so many of the usual measures that are appropriate during a time of stagnation—tax cuts, boosts in spending, genuinely deep cuts in interest rates—apparently fly in the face of the need to begin resolving the mess left by the excesses of the last ten years.

All this is not to say that it is impossible to improve the economy in its current condition, or to address the problems created by past errors or, indeed, to do both. There are in fact measures that the nation can take to encourage business today and to foster advances in productivity and competitiveness in the future. There are ways to reverse the trend to low investment and high consumption of the last decade without plunging the economy into a yet deeper shortfall from its potential output. But combining these objectives in a workable policy will require serious dedication, including a willingness to take actions that inevitably will be distasteful to one interest group or another, as well as a degree of legislative ingenuity that, at least in recent years, neither the President nor the Congress has been able to muster. In short, the challenge is very great. But then so is the need.

That 1993 presents a critical opportunity to take action on our economy has by now become a cliché. But this does not make the point less true. The economic history of our time has been radically different because Ronald Reagan in 1981 used his election mandate to support the tough measures, including record high interest rates, that Paul Volcker carried out at the Federal Reserve System in order to brake double-digit inflation. Three years later, voters rewarded the President for having done so, forgiving if not forgetting the record high unemployment that had temporarily ensued.

The economic history of our time would have been radically different in yet other ways if President Reagan in 1985 had followed his reelection victory by imposing some combination of spending cuts and tax increases sufficient to eliminate the very large budget imbalance his earlier policies had created. But he chose not to do so, and we thereby lost the chance to correct this problem while our economy was strong. In 1989 George Bush too missed his opportunity. Perhaps because he believed he could not violate his “Read my lips” campaign pledge, President Bush adopted an approach to our economy’s mounting problems that consistently amounted to too little, too late.

It is now Mr. Clinton’s turn. Because of the mounting economic damage done along the way, the easier options that were open to President Reagan in 1985, or even to President Bush in 1989, are no longer available. Our economy today is no longer strong but weak, and our debts are far greater. But unless we are to despair of ever restoring genuine prosperity in this country—a choice that would be wholly out of character both for America and for Americans—the accumulating cost of past inaction only makes seizing this opportunity the more urgent. Now is the time for positive action—not hints and promises, not symbols and tokens, but genuine new action on a scale adequate to correct a failure that has been building for ten years.

We now know that the American public’s dismal assessment of our country’s economic condition was more accurate than the Commerce Department’s. According to newly revised data the recession that began in the middle of 1990 was not so shallow after all. Total real output fell by 2.2 percent, not 1.6 percent as earlier reported, and the decline lasted not six months but nine months. More important, after over two years there is still no sign of a meaningful upturn. There are nearly three million more Americans unemployed than before the recession began (not even counting all the “discouraged” workers who have despaired of finding jobs and therefore stopped looking), and an additional 6 percent of the nation’s industrial capacity is idle.

These are real resources, and the economy’s failure to use them matters. The country’s rate of overall economic output, after allowing for inflation, is barely above what it was when the recession began—or, to put the matter in broader perspective, just 3 percent greater than in late 1988. Real growth since the end of 1988 has therefore averaged not even 0.8 percent per year, less than in any other four year period since before World War II. Americans’ real per capita income also remains below what it was four years ago.

Confronted by persistent stagnation, Congress and the President have taken no significant action toward a more stimulative fiscal policy. On a cyclically adjusted basis—that is, with both revenues and expenditures calculated as if the economy were at full employment—the federal budget (excluding transactions for the savings and loan bailout) showed a deficit equal to 2.6 percent of national income in the 1990 fiscal year. The Congressional Budget Office now projects that the cyclically adjusted deficit will rise to 3.5 percent of national income in fiscal 1993. This rise, not even 1 percent, is not a serious economic stimulus. It especially pales compared to the large fiscal measures enacted during or just after earlier business recessions in the postwar period, like those of 1957–1958, 1973–1975, or 1981–1982.

The reason for this inaction is no secret. The federal budget has never recovered from the three-part policy, adopted at the outset of the Reagan era, of tax cuts combined with a sharp buildup of defense spending and protection of expensive nondefense programs like social security and Medicare. The US economy has never recovered from this policy either. Budget deficits have fluctuated from year to year, of course, but throughout the last decade the deficit has remained far larger as a share of national income than in any previous period, apart from wartime or the Great Depression of the 1930s. Not surprisingly, draining away so much of the nation’s saving to finance the federal deficit has meant skimping on our investment in a more productive economy.

It is no wonder—and it is to their credit—that so many people now resist policies that would widen the deficit still further. The problem is that this welcome and well-founded attitude also means resisting the kind of fiscal stimulus that the United States has used before, often with noteworthy success, to spur the economy’s recovery from serious downturns.

At the same time, monetary policy has recently been stimulative but only cautiously so. The Federal Reserve System did not even begin to undertake a genuine easing of monetary policy for at least a year after the recession began. Within the last year, the Federal Reserve clearly has eased policy, so that short-term interest rates have now fallen by more than just the slowing rate of price inflation. Even so, it is easy to make too much of the measures that the central bank has taken to ease monetary policy. At 3 percent interest for three-month Treasury bills, for example, short-term nominal interest rates approximately match today’s inflation rate. Hence the real short-term interest rate—the excess of the nominal rate over the inflation rate—is about zero. To be sure, a zero real interest rate for short-term liquid assets is lower than that of a year or two ago. But in historical perspective it is not so unusual, especially for this stage of the business cycle. (The average real interest rate on three-month Treasury bills during 1950–1980, including recessions as well as periods of strong economic activity, was nearly zero—just 0.08 percent.)

The Federal Reserve’s reluctance to push interest rates still lower is, at least to some extent, also understandable. With short-term interest rates throughout Europe now several times the level of ours—for example 8 percent in the United Kingdom, nearly 9 percent in Germany, and over 10 percent in France—the widening gap between returns on dollar assets and returns available in other countries has caused investors to act in ways that have driven the dollar to new lows against the deutsche mark and related currencies. The Federal Reserve is naturally reluctant to press further with a domestic monetary policy that would steadily diminish the international value of our money. In light of the continuing stagnation gripping our economy, however, concern for the dollar should not be allowed to stand in the way of further steps toward an easier monetary policy.

Easier money has probably helped business already, and it will continue to do so in either greater or lesser degree as the Federal Reserve chooses. But no one has ever seriously recommended systematically leaving to monetary policy the entire task of boosting the economy out of recession. So the central question facing the new administration remains. Should fiscal policy be more expansionary now? If so, in what ways? And what about our decade-old problem of overborrowing and the underinvestment that follows from it?

In assessing just how weak our still nascent business recovery is, and therefore how pressing the need for additional stimulus from either monetary or fiscal policy (or both), the new administration will have to be honest about the appropriate standard against which to measure the economy’s actual progress. During the year and a half since overall business activity began to expand once again, the average growth rate after allowing for inflation has been 1.7 percent per year: disappointing, to be sure, but how much so? And compared to what? Should we have expected business to expand during this period at the 6 percent per year pace typical of the first year of most previous postwar expansions? Can we now plausibly hope that our economy will grow in the mid-1990s at the 3.1 percent per year rate that prevailed on average (albeit with many ups and downs along the way) from the 1950s through the 1980s?

Calculating precise expectations for productivity growth is a large and complicated task, but it is clear enough that the US economy’s development over the last ten years has been such as to limit our ability, during the years now immediately ahead, to achieve the kind of sustained expansion that we would otherwise have anticipated. In large part as a consequence of our misguided tax and spending policies, during the last decade we have underinvested in just about all of the basic ingredients of strong economic growth. During the last ten years, the federal deficit absorbed on average 3.7 percent of our national income. The entire net saving of American families and US businesses during this period amounted to just 6.2 percent of national income. As a result, the share of our income that we have devoted to investment in new plant and equipment has faltered. Indeed, by some standard measures it had already fallen to the lowest level of any sustained period since World War II, even before the depressing influence of the most recent recession took hold.

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