- The Washington Times - Tuesday, January 28, 2003

As President Bush begins final preparations for tonight's delivery of the State of the Union address, the Federal Reserve will have completed the first day of its semi-annual, two-day monetary-policy meeting. One important topic of tonight's speech will undoubtedly be the economy, in general, and fiscal policy, in particular. Tomorrow afternoon, the Fed will announce whether short-term interest rates will be reduced another notch. (That's not likely, but an official acknowledgement by the Fed that the economy has tilted toward weakness would be step in the right direction.) Later this week, the Congressional Budget Office will release its budget forecast, and on Thursday the Commerce Department will report its first take on economic growth for the fourth quarter, the consensus estimate for which is significantly below 1 percent. In this environment, it would be appropriate to review the fiscal- and monetary-policy records since Mr. Bush entered office.
As early as December 2000, to much derision from the outgoing administration, its congressional allies and the media, Vice President-elect Dick Cheney warned that recessionary forces may have already afflicted the economy. Fed Chairman Alan Greenspan and his colleagues understood the danger. Following an unusual meeting orchestrated between regularly scheduled meetings, the Fed engineered a hefty one-half-percentage-point reduction in the overnight federal funds rate on Jan. 3, 2001. The rate fell from 6.5 percent to 6 percent.
As it turned out, the Fed's Jan. 3 action was merely the first of 11 reductions in the federal funds rate during 2001. By year's end, following the most aggressive monetary-policy easing in years, the overnight rate had plunged by 4.75 percentage points to 1.75 percent. It was the first time in 40 years that the fed funds rate fell below 2 percent. In a surprisingly strong but welcome move, the Fed chopped another half-percentage point last Nov. 6, reducing its overnight target rate to 1.25 percent, its lowest level in more than 40 years. At the same time, it lowered the discount rate, which is the interest rate it charges banks that borrow from the Fed's regional branches, to an historic low of 0.75 percent.
On the fiscal-policy front, the federal budget has moved from a surplus of $236 billion in fiscal 2000 an inappropriate level that this page repeatedly warned was far too contractionary to a deficit of $159 billion in 2002. In between, of course, the economy fell into recession and the stock market continued to plummet following its peaks in early 2000. These trends slashed federal revenues, even as a long-delayed, terror-induced national-defense expansion caused outlays to rise.
Extremely well-timed 2001 tax reductions, which in hindsight should have been implemented much more aggressively (an unanticipated oversight Mr. Bush seeks to remedy now), also reduced federal revenues. Nevertheless, the contribution of tax relief to the emerging deficit pales compared to the piercing of the stock-market bubble and the recession the Bush-Cheney administration inherited.
The current fiscal year, which began Oct. 1, will almost certainly generate a deficit of $250 billion or more, even if taxes are not reduced in a timely manner and war with Iraq is not engaged. Thus, whether intended or not, in two years we have seen a half-trillion-dollar, fiscally stimulative spending swing. However, in the context of an $11 trillion economy that continues to show considerable weakness, the likely range of potential deficits is not only appropriate under the circumstances; it is also welcome as a necessary countercyclical force.
The Fed's aggressive action on the monetary-policy front has been spot on. Notwithstanding the moans of present-day Democratic Hooverites, the emergence of the deficit has also been a timely, welcome development. Imagine the condition of the economy in the absence of either policy trend: It's not a pretty sight.

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