The Matter with Reaganomics
Reynolds, Alan
Alan Reynolds THE MATTER WITH REAGANOMICS Will it meet the supply-side standard? Those who would blame our economic problems on last year's policy changes face a difficult task. They must...
...No short-term change in the amount of money could have prevented the bond market collapse that led to recession...
...the rest of us would have to borrow more-even to pay our taxes...
...We tried to tax our way out of a monetary crisis after we forced England off the gold standard in 1931...
...THE AMERICAN SPECTATOR MARCH 1982 19...
...Wall Street bond traders know that, though a few notoriously partisan economists claim ignorance...
...Taxing consumption is not fundamentally different from taxing incomes or saving (future consumption), and would not help...
...Bonds and mortgages are a promise to pay dollars in the distant future...
...And inflation clearly depends on how much money there is and how rapidly it is spent (velocity) relative to the growth of production...
...President Carter brought Treasury borrowing down from a $99 billion annual THE AMERICAN SPECTATOR MARCH 1982 17 rate at the start of the 1975 recovery to a negligible $8 billion by the second quarter of 1979...
...The difficulty with continuing to pursue fiscal solutions to the world monetary crisis is not that the initiatives are bad, but that they are irrelevant...
...For one thing, the shortage, uncertainty, and expense of new mortgages has vastly reduced the mobility of labor, which is crucial to dynamic efficiency...
...The deficit has risen since then, but conventional measures of money have slowed down...
...If those rates do not drop, monetary policy remains a failure, and a new approach must be tried...
...When Bill Niskanen of the CEA recently confirmed this sort of evidence, he was widely chastised for daring to introduce facts into a theological debate...
...Plenty of new money does not mean plenty of long-term credit...
...With government and business both borrowing more, interest rates must go up...
...Whatever this is, it is not a policy...
...The Administration has at least begun to talk about monetary policy, but the talk adds to the confusion...
...People, and the institutions that manage their assets, are unwilling to lend money for long periods of time without a very high yield...
...There are many possible ways of testing the theory that inflation and/or interest rates rise and fall with larger or smaller budget deficits...
...Still, there is no vis~le link between government borrowing and interest rates or inflation...
...We might be able temporarily to improve the government's cash flow at the expense of the private sector, but it is hard to see how this would help: The government could then borrow less...
...The only thing that has ever worked is guaranteeing to convert dollars into gold at a known price, adjusting policy levers to make that promise stick...
...Many seemingly separate problems-from the U.S...
...More production can help a bit, but no supply-sider ever said that tax cuts are the cure for inflation...
...Pledging to let interest rates approach infinity in order to slow MIB is enough to 18 THE AMERICAN SPECTATOR MARCH 198-2 scare anyone into borrowing before that happens...
...It spends like money but keeps M1B down, and each dollar of M1B then finances more spending than usual (that is, velocity speeds up...
...Nobody ever expects to win this fight, of course...
...Cut the deficit, .the Fed promises, and we'll pump up the money supply...
...A waste of scarce time...
...Anthony Solomon, president of the New York Fed, observes that "we may already be nearing the point where the Federal Reserve can influence the growth of these broad measures [of money] only indirectly by frrst influencing the behavior of the economy itself...
...As rates went up, people naturally kept more money in high-yield money market funds, overnight RPs, and Eurodollars...
...From the third quarter of 1980 to the same quarter of 1981, annual trends in nominal GNP rose from 8 percent to 12 percent--spending or "demand" accelerated as M1B slowed down...
...The real objection to the panicky push to pass new taxes is that it gives credence to the idea that another $15 billion in federal revenue will have an effect on inflation or interest rates...
...Chairman Volcker is also a firm believer in " s l a c k " (a euphemism for unemployment) as a way to fight inflation...
...So, I added state and local budgets, or federally guaranteed and sponsored loans, or private borrowing...
...They must somehow argue that the prospect of future tax cuts caused a recession, or that people would have gladly financed more long-term loans at lower interest rates had they been assured the Fed would keep printing lots of money...
...What they got was not a bit different from Jimmy Carter's policy: Inflation is something you constantly "fight" by narrowing the budget deficit...
...budget deficit to the Polish debt crisis--are actually symptoms of a single problem: Long-term credit is too scarce and too expensive...
...We don't even know what the Fed is going to do from one week to the next, or what it is trying to do and how it intends to do it...
...Poland is now proposing more taxes to solve its own monetary collapse...
...The government is groaning under a $100 billion annual interest expense for the same reason that corporations are dangerously dependent on short-term loans and young households are stuck with onerous three-year mortgages...
...Interest rates, on this theory, should also be lower in Argentina than in Switzerland...
...In its original form, the Reagan policy was to lean primarily on reducing marginal tax rates to improve real growth, and to construct a long-term monetary policy to end inflation...
...The Fed can expand the nominal quantity of money, but cannot thereby increase the real value of the money stock, much less the attractiveness of investing in claims on future dollars (bonds...
...I also compared each of these series with the volume of savings or total borrowing...
...That was not unusual...
...In each case, no link was found between deficits and inflation (or interest rates...
...it usually means the opposite...
...I am quite concerned about the government's budget strains, but I am also concerned about the similar financial problems of American households and enterprises...
...Yet recessions do not provide any lasting relief from inflation...
...In the entire history of our country, long-term interest rates almost never exceeded 5 or 6 percent...
...Federal deficits are a consequence of the global monetary crisis, not the cause...
...Mortgage interest rates were below 6 percent...
...To sum it up, the collapse of bond markets reflects expected inflation and inflation depends on monetary policy...
...The hard truth is that the nation still has no plan m get inflation to near-zero and keep it there...
...What is needed is to make bonds a safe investment again...
...That is the silliest idea since the OMB's "September initiative" which was supposed to make bonds more valuable by trimming $4 billion off federal spending...
...If the long-term doubts about the dollar were solved, short rates would take care of themselves...
...doesn't work...
...Yet we have had much larger deficits before, relative to the size of the economy, and long-term interest rates were never even half of what they are today...
...Those of us with three-year 15percent mortgages are growing impatient...
...the mass media adopted an extreme Keynesian theory, wrongly blamed on Wall Street, that the collapse of bond and mortgage markets was entirely due to the budget deficit...
...We have no predictable monetary policy at all, no way of knowing what monetary authorities intend to do in the years ahead or how or why...
...This assumes either that inflation is good for growth, or that an increase in the money supply could lower long-term interest rates...
...According to Henry Kaufman of Salomon Brothers, there is supposedly a "clash" between tax-rate cuts to expand real GNP and a monetary policy to slow the growth of nominal GNP or inflation...
...As Maury Harris of Paine Webber put it, "high federal deficits primarily reflect the impact of Fed-related high interest rates both on depressing economic activity and tax collections and raising government interest costs...
...If interest rates were anything close to normal, the budget would be in surplus...
...The shortage of long-term credit cannot be solved by enticing people to save a larger share of existing production, because that production is too low and added savings are just flowing into short-term money markets...
...That is not an improvement...
...Inflation also looks better by some measures, though it is scary when officials seem pleased by an 8.4 percent GNP deflator in the fourth quarter (the 1980 average of 9 percent was the worst since 1975...
...If the plan shows promise, long-term interest rates will drop like a stone...
...And contrary to economist John Rutledge, large losses on real estate do not necessarily make the losers anxious to buy bonds...
...A supply-sider, we are repeatedly told, is anybody who thinks "deficits don't matter...
...Since nobody really believes that tax cuts cause recession or that loose money is good for bond and mortgage markets, there has been no criticism of the Reagan fiscal program that can be taken seriously, nor any serious alternatives offered on the tax and budgetary side...
...I am often told that "gold is not the answer," but those who seem most certain about that have not yet asked the right questions...
...Dave Stockman, however, soon elevated a balanced budget as the sole objective, neglecting important deregulation (e.g., n~ttural gas) and totally ignoring any long-term monetary reform...
...The value of future dollars, in turn, is mainly dependent on future monetary policy...
...Indeed, inflation worsened during the last two recessions, and has almost never improved significantly for even a single year after recession...
...There must be a credible long-term plan to maintain the purchasing power of the dollar over decades...
...The Fed understands how arbitrary the measures of money are becoming, but not what to do about it...
...What theFederai Reserve is doing right now, or what the latest price index says about current inflation--these things are at best indirect clues to the future...
...The problem is not in anything the Reagan Administration did, but in something it did not do...
...Since that time, the cost of long-term financing has gone higher and higher, regardless of the savings rate, and regardless of the budget surplus of 1969 or the shrinking deficit from 1976 through 1979...
...The nation and the world are adrift without a monetary anchor, without a durable unit of account...
...Ignore the White House political advisers, who are inherently afraid of meaningful change...
...In late January, the prime rate was four percentage points lower than a year before, but long-term interest rates were two percentage points higher...
...Inflation either had nothing to do with money, or else monetary policy was the helpless victim of federal borrowing...
...Fed governors would also have us believe that deficits and money growth are interchangeable substitutes...
...We can prudently ignore short-term interest rates, like the bank prime rate...
...It is not possible to exaggerate how dangerous this situation is...
...Stockman and...
...The economy's precarious dependence on short-term credit mirrors the growing unwillingness of people, and the institutions entrusted with their savings, to commit funds for long periods of time--to finance bonds, stocks, or mortgages...
...In each case, adherents to the fiscal theory proposed yet another test...
...Convene economists from the Treasury, the Council of Economic Advisers, and the Federal Reserve and ask them to nail down a monetary policy that will instill long-term confidence in money...
...My monetarist friends claim to have a few more technical adjustments, or a secret plan, that will do the job...
...That has always been an implicit promise of Reaganomics, and has always been a central plank of classical supply-side economics...
...We tried a tax surcharge to fix our next defiance of the gold standard in 1968...
...In fact, the volume of credit has been generally weak since 1979...
...That is, we could fight inflation with budget deficits and slow money growth, or we could fight inflation by balancing the budget and printing lots more money...
...To slow some arbitrary measures of money, the Fed feels obliged to toss an occasional credit crunch to flatten the real economy...
...I have looked at federal budget and off-budget deficits as a share of GNP, related Treasury borrowing to Federal Reserve purchases of securities, and compared deficits with inflation and interest rates in a dozen countries...
...Everyone assumed that supp!y-siders abhor all of Mr...
...Since nobody in his right mind thinks deficits don't matter, this implies that supply-siders are mentally deficient...
...They did that for President Carter, a~er all, and we saw what happened...
...Long-term interest rates clearly reflect expected inflation...
...Inflation and interest rates did not go down, they went up...
...I looked into U.S...
...Sprinkel thinks the Fed did well " o n average," Regan and Gergen once wanted a bit more M1, but the President thought one weekly number was too big...
...Businesses, households, and governments could then reduce their precarious dependence on short-term credit, making short-term interest rates lower and more stable...
...Hold an international monetary conference, like Bretton Woods but better...
...How can a household," with a variable-rate or balloon mortgage, plan its finances when future mortgage payments may be unbearable...
...When taxes have long been stated as a specific number of pennies, like the gasoline tax, it makes some sense to bring taxes up to compensate for past inflation...
...nor should he with such meaningless tools and objectives...
...Give Stockman a vacation, or lend him to Poland...
...Poincare did that in France in 1926, but he also cut income tax rates in half and restored the gold standard...
...Markets were initially euphoric because they also expected a new policy to end inflation...
...The Fed manipulates overnight interest rates to influence the nonborrowed part of bank reserves in order to approach shifting targets for a variety of measures of money in the hope of having some unspecified impact on total spending and thereby perhaps either affecting inflation, engaging in countercyclical fine-tuning, or manipulating interest and exchange rates...
...Indeed, the long-term interest rate reflects the expected trend of short-term rates, so it is now telling us that any easing of short-term rates will be very brief...
...It is not simply that long-term interest rates are still too high, though they certainly are, but that b6rrowers cannot know whether they are going to end up high or low after adjusting for unknown future inflation...
...Trouble in long-term markets requires a long-term solution...
...and.foreign history...
...Stockman's proposed excise tax hikes, but I was rather indifferent about it...
...Additional support was to come from slowing the growth of federal spending, and making regulations less capricious and less costly...
...The interest rate on such claims to future dollars clearly depends most of all on the expected future purchasing power of the dollar...
...There has been a fundamental Ioss of confidence in managed k money, and there is not likely to be a managerial solution...
...Our third experiment with fiat money began, symbolically, with the elimination of silver coins in 1964, the two-tier pricing of gold in 1968, and the final repudiation of our national pledge to convert dollars to gold on August 15, 1971...
...Constant fiddling with changes in spending and taxes, where additional changes are now necessarily quite small, simply diverts attention from genuine solutions to genuine difficulties...
...This is not a coincidence...
...The central economic trauma is quite obvious...
...It is not a new problem, but has accelerated markedly since the 1968-73 moves away from gold...
...Let us take a look at any concrete monetary reform...
...The Kaufman-Stockman theory is that the volume of borrowing determines its price...
...T h i s is not to let the Fed off the hook...
...hat sounds plausible, but so does the exact converse: If interest rates go up, there will be fewer dollars borrowed Nexther statement is enlightening...
...The high yield is to compensate for the risk that today's dollar may be worth a dime when 20-year bonds and mortgages are paid off...
...This is what Mr...
...It Alan Reynolds is chief economist at Polyconomics, Inc., and former vice-president of the First National Bank of Chicago...
...That won't work, either...
...No indexing scheme quite gets around this problem...
...Yet they have been saying that for a decade since Nixon, on their advice, ended the last institutional guarantees of the quality of money...
...In short, the Fed uses inadequate tools to hit irrelevant targets in order to meet unknown or unachievable objectives...
...Annual recessions, unknown since 19181920, are the Fed's new technique for lowering credit demands by bankrupting borrowers...
...In 1965, corporations could finance new investments by selling long-term bonds at 4.5 percent...
...Solomon means when he says "we shouldn't overload monetary policy with the full burden of countering inflation...
...The only exceptions were during the two previous experiments with irredeemable paper money--Continental currency in the Revolutionary War, greenbacks in the Civil War...
...That sort of fear provokes retrenchment, and the problem is pervasive...
...If true, bond yields would have been much lower in the seventies, When money was abundant, than in the sixties...
...The interest rate at which borrowers and lenders strike a deal does not depend on how much money changes hands...
...For over a dozen years, we have seen an accelerating loss of confidence that the dollar will hold its purchasing power in the future, and therefore a growing unwillingness to commit funds to the long-term investments needed to keep the economy from deteriorating...
Vol. 15 • March 1982 • No. 3
