This week's main event takes place today, when Federal Reserve Chairman Alan Greenspan goes up to Capitol Hill to deliver the Fed's semi-annual monetary report to Congress. His appearance will overshadow economic news on industrial production, consumer prices, housing, trade and regional manufacturing, all of which are expected to show a dead-in-the-water economy.
Here's where Arthur Burns comes in. Before his inauspicious tour of duty as Fed chairman from 1970 to 1978, where he was suspected of pumping up the money supply to ensure Richard Nixon's reelection in 1972, Burns had a distinguished economic career. A professor of economics at Columbia University, Burns and co-author Wesley Mitchell published Measuring Business Cycles in 1946, which was as empirical as Keynes's General Theory was theoretical.
Burns was one of the few anti-Keynesians in an era where, to quote Nixon, we're all Keynesians now.
Burns had a major influence on graduate student Greenspan, as documented in Justin Martin's biography, Greenspan: The Man Behind the Money (the ``other'' biography that came out at the same time as Bob Woodward's hero worship).
An anecdote from Martin's book is instructive. It answered a question that has long plagued me about Greenspan's thinking. In Martin's retelling, Burns used to ask his graduate students, ``What causes inflation?'' Burns would pause, pan the room, before answering his own question: ``Excess government spending causes inflation.'' That paragraph on page 29 was an epiphany for me. All these years of watching and listening to Alan Greenspan, I've never understood how the one-time member of Ayn Rand's collective could prefer debt reduction to tax cuts (at least until it was politically prudent for him to support them when George W. Bush became president).
While the idea that government spending was inflationary was popular at the time -- the federal government borrows to finance its spending, and the central bank then monetizes it by buying the debt -- the thinking is more sophisticated today. While spending by the government is less efficient than that of the private sector since it isn't sensitive to price signals, it doesn't matter who borrows and spends. The central bank always has the ability to offset it.
An increase in government spending, all things equal, would cause interest rates to rise. Nothing says the central bank has to accommodate the increased demand for credit, supplying sufficient reserves to prevent the short-term rate from rising.
If Greenspan really believes that excess government spending causes inflation, not too much money chasing too few goods and services, everything falls into place. There is never any mention of inflation as a monetary phenomenon in Greenspan's speeches and testimonies. In fact, anyone whose sole source of insight into the Fed's thinking is the minutes of the policy deliberations would be convinced that higher energy prices cause inflation. Second in line would be a tight labor market and the higher wages it engenders.
"Widespread evidence of some lessening of pressures in most labor markets across the nation had not yet resulted in lower wage inflation, but the members expected that recent and anticipated ebbing of pressures on labor and other resources and associated slack in product markets in a period of continuing sub-par economic growth, along with projected declines in energy prices, would hold down inflation over the forecast horizon," the Fed said in the minutes from the May 15 meeting.
To be sure, Greenspan has gone out of his way in the past to explain that higher wages aren't inflationary per se, but only to the extent that they exceed productivity growth. But he never gets to what causes wages to rise -- or a wage/price spiral to be maintained -- in the first place. It's always something outside the Fed when in reality it's always and everywhere inside the Fed, to paraphrase Milton Friedman.
Whatever Greenspan has to say on the outlook for the economy today -- he may be cautiously optimistic that the forces to produce a rebound are in place, or he may be guardedly pessimistic, saying risks remain but in a manner that will not upset the stock market -- he surely will say that the outlook for inflation is benign, given the collapse in energy prices.
Congress, as always, will want to hear from the monetary authority on fiscal policy. Why is unclear, since Greenspan always warns against frittering away revenue on wasteful spending.
Democrat congressmen are whining about a return to budget deficits as a result of the US$1.35 trillion Bush tax cut. The truth is the surplus for the year that ends Sept. 30 will be between US$160 and US$190 billion, according to budget director Mitch Daniels.
While that's shy of last year's US$237 billion surplus, "it's still the second-largest surplus on record, allowing more than US$125 billion of Treasury debt to be retired," economists at Salomon Smith Barney write in this week's Comments on Credit.
Greenspan will probably hawk his optimistic view that the improvement in productivity growth since 1995 has been structural, not an offshoot of strong economic growth. And it's productivity growth -- specifically the increase in the economy's potential non-inflationary growth rate from a measly 1.4 percent in the two decades prior to 1995 to 2.5 percent from mid-1995 through mid-2000 -- that made federal deficits morph into federal surpluses.
The Fed Chairman probably won't encounter tough questioning from the House Financial Services Committee today. The following week, when he repeats his testimony on the Senate side, Banking Committee Chairman Paul Sarbanes, an economist by training, should have a question or two on the subject.
Last February, Sarbanes drilled Greenspan on the reasons for his shift in stance on tax cuts. Greenspan said an increase in structural productivity growth meant reducing publicly held debt to zero by 2007 was a reality. In order to obviate the conflict of interest in the government's purchase of private securities, Greenspan decided a tax cut at this time was appropriate.
Senator Sarbanes: "You think the six-month period of a slowing economy is adequate to reach a conclusion that the productivity performance will track what it was in a growing and expanding economy?" Sarbanes will return to the scene of the crime, now that the US$1.35 trillion tax cut has been implemented and surplus forecasts are shrinking.
It used to seem strange that Congress was more interested in Greenspan's view on fiscal policy than on monetary policy, which is what he controls. In light of the insights shed by Justin Martin on Greenspan's mentor's view of what causes inflation, Greenspan seems perfectly suited to the task.
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