Though loath to admit it publicly, President Clinton and his economic advisers know that the Administration's deficit-reduction package recently passed by Congress will have a sharply contractionary direct effect on the U.S. economy over the next four years. And yet they continue to speak hopefully of future growth in jobs and income.
The key to their hopefulness, of course, is their faith that a substantially reduced federal budget deficit will foster low interest rates, which in turn will stimulate the economy--outweighing the directly restrictive fiscal effects of deficit reduction. "If there's anything that this program is directed at," Robert Rubin, head of Clinton's National Economic Council, acknowledged back in February, "it's interest rates."
But these hopes require cooperation by the Board of Governors of the Federal Reserve. If the Fed gets squeamish about accelerating inflation, it can move to increase interest rates and quickly dash hopes of renewed economic growth. The White House has thus placed the fate of its economic program--and our future jobs and income--in the hands of Fed Chairman Alan Greenspan and his colleagues. Would you buy a used car from these folks?
Let's first explore what is at stake with Fed policies and then consider the interests that are likely to guide those policies over the next four years.
As we all know, pressure had been mounting for several years to substantially reduce the federal budget deficit. In its initial economic proposals, the White House hoped to leaven the deadening contractionary effects of sharp deficit reduction with a tiny bit of short-term stimulus in 1993 and 1994. Once the Senate Republicans were through filibustering the stimulus package, however, the Administration was left standing on only one leg, committed to a deficit-reduction program that would, over the next four years, through its own direct effects, dramatically dampen economic growth.
Based on standard mainstream economic models, it would be reasonable to project that the net anticipated reduction in the deficit over the next four years, everything else equal, would directly result in a decline in national output of somewhere between 1% and 2%. This would in turn result in rising unemployment and stagnant or declining incomes.
The Administration hopes and prays that "everything else" will not be equal. It rests its case for favorable economic prospects on the possibility that the Fed and financial markets will be so pleased with the reduced federal deficit that they will encourage lower interest rates over the full period of the deficit reduction.
But this faith in the Federal Reserve Board presumes that the Fed and financial markets will play along, advancing the interests of the White House and the general public. And that would presume that the Fed cares just as much about jobs and income as the rest of us.
It doesn't. Once appointed by the President, the Fed governors are completely independent of the legislative and executive branches, beholden to no democratically accountable officials or institutions. If they listen to and care about anyone, it is the needs and interests of the financial community.
Banks and investors tend to worry most about the rate of inflation--about how rapid and unstable an increase in prices is likely to be.
For most of the rest of us, relatively rapid economic growth serves our needs and interests by boosting income and enhancing employment opportunities. But in many circumstances, more rapid growth can generate more rapid inflation--anathema to the financial community.
It would thus be surprising if the Fed, with its ears to the ground for tremors from Wall Street, would cooperate in promoting more rapid economic growth. That's not what it cares about most.
Sure enough, just as the budget was squeezing through Congress, Alan Greenspan was telling lawmakers that he was getting worried about inflation and that the Fed might have to move toward tighter monetary policy fairly soon. "The signal we are endeavoring to send here," Greenspan testified, "is, at some point, rates are going to have to move up."
What options are left to the Administration? There is little the White House can do under current arrangements. Given the political independence of the Fed, the Board of Governors can follow its own course largely as it sees fit.
And so, once again, we directly confront the potential costs of the political independence of our central bank. No matter how responsibly the President and Congress behave, the Fed can continue to place the needs and interests of the financial community above those of nearly everyone else. If the Fed does jilt the President and raise interest rates, perhaps we will finally begin to ask much more fundamental questions not simply about Fed policy but Fed power.