I don't like being known as a critic of Fed Chairman Greenspan. I really don't. I take no joy in busting Mr. Greenspan's chops. I'd be a much happier man, professionally and personally, if I could heap praise on Mr. Greenspan more often. And, indeed, until about four years ago, I was a cheerleader of Mr. Greenspan for his economic acumen and political leadership.
What changed? Mr. Greenspan developed a nasty habit of refusing to "own his priors," as we economists like to say. Or, as more normal people might say, Mr. Greenspan developed selective memory, alternating with selective amnesia. And that has infuriated me, both professionally and personally, in the nature of carpenter ants running up my pant leg.
In the investment management business, we have no choice but to "own our priors." Such priors are called our performance record. There is, to be sure, no rule against blowing smoke on this side of the street. But if you put money behind your smoke, you gotta live with it forever. You can't just pretend you didn't inhale. It stays in your performance record, illuminated forever by ever-more sophisticated techniques of performance attribution analysis.
Not so in Washington, of course, where pretense is a way of life and duplicity is the currency of the realm. The Fed is part of this political milieu and, as such, is not immune from second-hand smoke. And indeed, the Fed shouldn't be immune to the inherent messiness of the democratic political process. 1 The chairman of the Federal Reserve is known as the "second most powerful man in the country" for a simple reason: He is, at least in economic policy matters, because the Fed has politically-granted monopoly power over the press that prints the nation's money. That, my friends, is a political job!
Politics Is As Politics Does
The Fed is independent within the government, but not independent of the government. More specifically, the Fed has the right to peg the Fed funds rate as it sees fit, but must exercise that right in the context of goals established by the political process . And in the Fed's case, there are three explicit goals established in 1978 legislation known as the Humphrey-Hawkins Act: " to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."
To Mr. Greenspan's credit, he has championed the cause of greater Fed "transparency" in the ways and means of the Fed's monopolistic manipulation of short-term interest rates. Most visibly, Mr. Greenspan has led the charge for the Fed in (1) candidly admitting that pegging the Fed funds rate is indeed what the Fed does, and in (2) announcing immediately both changes in the peg and the Fed's leanings (bias) toward changing the peg.
These things may seem obvious now, but they weren't under Mr. Greenspan's predecessor, Paul Volcker. He liked to foster "constructive ambiguity" as to whether the Fed really had the power to peg short-term rates, leaving it up to analysts reading the tea leaves of open market operations (the band of analysts first dubbed Fedwatchers over twenty years ago, in which I played trombone for E.F. Hutton!) to declare whether the Fed had changed its non-peg for the non-pegged Fed funds rate. Yes, we've come a long way, baby.
The Fed under Greenspan has indeed become more transparent in the implementation of monetary policy. In contrast, however, I believe the Fed has become much less transparent explaining its role in the context of legislated goals . Say what you want about Paul Volcker, the man was clear as to his mandate: bring down the inflation rate, even at the cost of recession.
He didn't blow smoke about this, even as he fuzzied up the truth of implementation of policy. I remember sitting behind him as he testified before Congress (this was way back, even before CNN and CNBC!), hearing him bluntly tell legislators that he was doing what the law told him to do, and if they didn't like it, they could change the law! In a cloud of literal smoke from his ever-present (cheap!) cigar, Mr. Volcker also lectured legislators about the evils of budget deficits, of course, as central bankers must do.
But most of the time, his preaching against deficits was in the context that deficits were frustrating his ongoing - legislated! - war against high inflation. Mr. Volcker didn't try to run fiscal policy; he just explained that the easier fiscal policy was, the tighter he would have to be on monetary policy, in order for the Fed to win the secular war against inflation . Essentially, Mr. Volcker stuck to his day job as head of monetary policy, and only moonlighted in fiscal policy analysis/formulation.
In contrast, Chairman Greenspan considers giving fiscal policy advice to presidents and legislators to be part of his day job. And, unlike Mr. Volcker, Mr. Greenspan doesn't cast his fiscal policy advice in the context of aiding the Fed in the pursuit of its three legislated goals, notably the pursuit of "price stability." Rather, Mr. Greenspan has always aspired to being a player in the setting of fiscal policy itself.
From Preaching To Meddling
Mr. Greenspan has achieved his personal goal: he is a huge player in fiscal policy formulation. Indeed, when presenting the Fed's semi-annual Monetary Policy Report to Congress 2 three weeks ago, he found it necessary midway to declare:
"..in view of the major budget issues now confronting the Congress and their potential implications for the economy, I thought it appropriate to devote some of my remarks today to fiscal policy. In that regard, I will not be emphasizing specific spending or revenue programs. Rather, my focus will be on the goals and process determining the budget and on the importance, despite our increasing national security requirements, of regaining discipline in that process. These views are my own and are not necessarily shared by my colleagues at the Federal Reserve."
To the best of my memory (which is pretty good in these matters!), this was the first time that Mr. Greenspan has explicitly found it necessary, while reporting by legislative necessity (thank you, former Senator Gramm!) on his legislated day-job responsibilities, to declare that he was taking an ad hominem walk on the fiscal policy side. Following which, he gave legislators a tutorial on the merits of accrual accounting for fiscal policy!
Nothing wrong with that, I suppose. But then, he went from preaching to meddling, as people where I grew up used to say about preachers who got too personal in their admonishments about sin. Specifically, answering a question with words calculated to have impact on real-time fiscal policy formulation, he declared:
"I'm one of the few people who still are not as yet convinced that stimulus is a desirable policy at this particular point. It depends very much on how one reads what is effectively going on under the whole structure of geopolitical and other risk. And unless and until we can make a judgment as to whether, in fact, there is underlying deterioration going on - and my own judgment is, I suspect not - then stimulus is actually premature.
And I support the president's proposal on eliminating the double taxation not as a short-term stimulus measure but as, I think, long-term good corporate tax policy and something which would add to the long-term flexibility and potential growth of the economy. But unless it turns out that there really is a very weak underlying structure even beneath this degree of uncertainty, which I will grant you will then change our view with respect to desirability of stimulus beyond what has already been put in place by the Federal Reserve in its fairly significant decline in short-term interest rates, we have to be in a position to be able to state that we see that as a very significant problem and one which must be addressed in a manner which would then clearly be necessary.
I suspect it is not, but I cannot say with any degree of assurance that I feel comfortable with that conclusion."
I'll never forget the surreal feeling that came over me as I watched Greenspan on CNBC as he uttered these words: here is a man who wants us to believe that which he doesn't really believe himself! The sensation reminded me of my youth, when I heard evangelic ministers - not my Dad, I stress! - preach against the evils of pride, even though they were egomaniacs themselves. This was the same man - speaking as Chairman of the Fed and before he had segued with his these-are-my-own-views caveat into fiscal policy - who had just said:
"..on November 6, with economic performance remaining subpar, the Federal Open Market Committee chose to ease the stance of monetary policy, reducing the federal funds rate 50 basis points, to 1¼
percent. We viewed that action as insurance against the possibility that the still widespread weakness would become entrenched. With inflation expectations well contained, this additional monetary stimulus seemed to offer worthwhile insurance against the threat of persistent economic weakness and unwelcome substantial declines in inflation from already low levels."
Mr. Greenspan's raw hubris had never been so vividly displayed. Monetary easing "insurance" had been applied, and Greenspan admittedly could not comfortably conclude that it would be successful. Yet he was not yet convinced fiscal policy easing would be desirable, labeling the idea "premature." Premature?
Excuse me, but I've always thought of buying insurance as appropriately premature. Rational people do not wait to call their insurance agent from a ditch beside the highway, but rather make that call before they get into their motor vehicles. Rational people are particularly inclined to do so, if and when their gut tells them that their four-ply radial tires might be too bald to get traction in a rainstorm. But not Mr. Greenspan.
"We All Knew..."
"Oh, cut him a break," I hear some readers retorting, and some of my PIMCO colleagues have already said it: "Monetary easing insurance can be taken back if it proves to be unneeded, but fiscal easing lasts forever, as Congress never takes back goodies once it has bestowed them." I understand that view. Indeed, Mr. Greenspan's view as to the efficacy of delaying/reducing/repealing President Bush's phased income tax cuts of two years ago is ironic testimony to the inherent asymmetry of the fiscal policy easing. When explicitly asked before the Joint Economic Committee of Congress last November 13, Mr. Greenspan declared:
"I believe to maintain sound fiscal policy that it is important to constrain outlays, in which case you have a much lower level of taxation, which I think is important for economic growth. I think it would probably be unwise to unwind the long-term tax cut because I think it is already built into the economic system and I think there would be potential adverse consequences, which I don't think are desirable."
Mr. Greenspan offered this blatantly political view of fiscal policy, despite having acknowledged two months earlier, on September 12 before the House Financial Committee, that he had known that the surplus projections of two years earlier were fanciful. Specifically, he said:
"..there were very considerable technical difficulties in budget estimation which confronted both OMB and CBO. We all knew that the rise in individual income tax receipts was far in excess of anything that could be determined by what we would call the tax base. We knew that a very substantial part of that rise in revenues relative to income was a consequence of stock-price effects one way or the other.
And what that essentially means is that the expectations of the relationship between the stock market, capital gains, stock options, bonuses, withdrawals on 401(k) and IRAs, all were overestimated."
In an era of looking for smoking guns, it seems to me Mr. Greenspan's acknowledgement that "we all knew" the surplus projections were inflated by the stock market bubble is an acrid smelling firearm. Yet Mr. Greenspan counseled against reconsidering structural tax cuts founded on bubble-boosted revenue projections, because economic players have built the tax cuts into their expectations. Where I grew up, prideful preachers preaching against pride were called holier-than-thou hypocrites.
But perhaps I'm too harsh. Three weeks ago, Mr. Greenspan actually came clean on what he saw as the goal of President Bush's long-term tax cuts:
"..one of the reasons that I was in favor of a tax cut two years ago was to prevent the accumulation of private assets by the federal government, which I think is a very bad idea, still think it's a very bad idea.
Remember, at that time, there were a number of tax cuts on the table. It wasn't just the president's tax cut. The issue here is if the president's tax cut didn't pass, another, very significant tax cut would have passed, which I would have thought would have been fine, because it (tax cutting) needed to take the surplus off the table. And I think clearly that happened."
Talk about smoking firearms! Mr. Greenspan acknowledged that surplus projections were stock market bubble creations, and that he knew they were at the time. Yet he defended clinging to tax cuts designed to take the surplus "off the table," when it was self-evidently true that bursting of the stock market bubble had cleared the surplus-revenue table and cut off its legs.
Deductive logic leads ineluctably to the conclusion that Mr. Greenspan politically believes in a smaller government, and buys the famous fiscal doctrine of President Reagan - treat Congress like you treat children who spend too much: cut their allowance!
I actually have no problem with those who espouse that doctrine, even though I don't personally share it. I do, however, have a problem with the Fed Chairman preaching that doctrine successfully, and then using the deficits begat by that "success" as an excuse for rejecting fiscal easing, even as he openly declares that he "cannot say with any degree of assurance" that he is comfortable that monetary easing alone will get the economy cyclically moving.
I remember when I was a child hearing Dad preach "an excuse is nothing more than the skin of a reason, stuffed with a lie." Hearing Mr. Greenspan testify on the putative need for fiscal policy discipline was a flashback experience. Mr. Greenspan's advocacy of fiscal discipline had nothing to do with winning a war against inflation, as was the case with his predecessor Paul Volcker. That war has been won, as evidenced by Mr. Greenspan's own acknowledgement that last November's monetary easing was insurance against "unwelcome substantial declines in inflation from already low levels."
Mr. Greenspan's sermonizing against Keynesian fiscal stimulus also had nothing to do with any cyclical instability in Uncle Sam's debt structure (Figure 1) or interest burden (Figure 2). To his credit, he acknowledged this three weeks ago, declaring:
"Actually, it turns out that we do not really have a fiscal problem of moment until we get beyond the end of this decade, largely because the underlying growth rate and the structure of interest rates at this stage keeps deficits - even under the president's program - beyond these next two years in an area where the rate of debt to GDP does not move up in any way which suggests we are in an unstable system. (It is not until) you get beyond this decade, when you get into 2011, 2012, the ratio of debt to GDP begins to rise to a very worrisome manner."
Cyclical deflation risks alongside cyclical stability in Uncle Sam's balance sheet are a perfect platform for proactive cyclical fiscal easing, Keynesian style. Yet Mr. Greenspan rejects the proposition as "premature." I don't know whether rumors that the White House is unhappy with Mr. Greenspan are true or not. What I do know is that they should be true!
Not that I'm enamored with the White House's putative stimulus package. I'm not, as it is diluted Keynesianism, at best. A proper Keynesian cyclical fiscal stimulus would include (1) federal revenue sharing with state and local fiscal authorities struggling with pro-cyclical constitutional fiscal strictures; and (2) payroll tax relief for the greater-than-one-half of Americans who pay more in payroll taxes than they do in income taxes. President Bush's proposal does neither of these two things.
But I applaud the White House for refusing to worship at the Church of Rubinomic Fiscal Discipline, featuring smaller-government Republican Greenspan as guest pastor. Only Democrats who don't think and/or who don't want to get elected or re-elected worship there anymore.
Regrettably, this includes most of them.
Paul A. McCulley
March 1, 2003
1 See "Suspicions," Fed Focus, September 2002.