- The Washington Times - Wednesday, July 2, 2003

In November, after Federal Reserve Chairman Alan Greenspan and his central bank colleagues lowered their target short-term interest rate a larger-than-expected half-percentage point, Mr. Greenspan told Congress’ Joint Economic Committee that the U.S. economy was mired in a “soft spot.” The interest-rate reduction represented affordable “insurance,” Mr. Greenspan explained, in order to prevent the economy from relapsing into recession. It was good anticipatory policy.

At the time, Mr. Greenspan suggested that a 2003 tax-relief plan, which the White House was then assembling and which the newly elected Republican-controlled Congress was eagerly anticipating, might not be necessary in view of the Fed’s recent actions. In January, President Bush effectively ignored Mr. Greenspan’s warning against additional fiscal stimulus. The president presented a sizable tax-relief program to Congress, which enacted a $350 billion legislative package in relatively short order.

Since Mr. Greenspan’s soft-spot testimony, the U.S. economy has continued to stagnate, limping along at an annual growth rate of about 1.5 percent over the past three quarters.

Now, even Mr. Greenspan acknowledges the timeliness of the heavily front-loaded tax-relief plan, which will inject $210 billion of additional fiscal stimulus into the U.S. economy’s soft spot over the next 15 months. Beyond the stimulus provided by the tax cut, moreover, last week the Fed increased stimulus on the monetary front by lowering short-term interest rates by another quarter of a point.

If the U.S. economy has been mired in a soft spot, many other major industrial economies, including Japan and Germany, have been faring worse. Growth in the eurozone has come to a virtual halt, while Japan faces accelerating deflationary forces that threaten its entire financial system. So, it was hardly surprising that the Bank for International Settlements (BIS), a forum for central bankers, borrowed Mr. Greenspan’s metaphor in its recent annual report reviewing the performance of the world economy during the four quarters ending March 31. Understatedly, the BIS report characterized the condition of the global economy as “an uncomfortable soft spot.” The BIS report appropriately lamented that “[g]rowth in most of the large industrial countries failed to meet earlier expectations, in spite of ample policy stimulus.” Meanwhile, in the presence of unused capacity and in the absence any corporate pricing power, “deflation either emerged or threatened in a number of countries.”

Inexplicably, however, the BIS also chastised U.S. policy-makers for generating additional fiscal stimulus. Yet, by the BIS’ own admission, “ample policy stimulus” has already failed to restart any of the global economy’s engines. Meanwhile, Japan has been in a long-running state of policy paralysis, the bureaucrats at the European Union are browbeating an economically supine Germany over its cyclical budget deficit and the European Central Bank is fiddling while the euro is soaring in a deflation-inducing upward spike.

In its conclusion, the BIS instructs “prudent” policy-makers to “be prepared to address the possible implications if growth were to falter.” Preparing reactive policies may be a good idea. But, pursuing anticipatory policies to lessen the chances of having to “address the possible implications” of disaster is clearly a much better idea.

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