John Taylor, the "Fed Chairman who should have been", has penned a terrific op-ed in the WSJ. Must Read.
The End of the Growth Consensus
America added 44 million jobs in the 1980s and '90s, when both parties showed they had learned from past mistakes. The lessons have been forgotten.
By John Taylor
This month marks the two-year anniversary of the official start of
the recovery from the 2007-09 recession. But it's a recovery in name
only: Real gross domestic product growth has averaged only 2.8% per year
compared with 7.1% after the most recent deep recession in 1981-82. The
growth slowdown this year—to about 1.5% in the second quarter—is not
only disappointing, it's a reminder that the recovery has been stalled
from the start. As shown in the nearby chart, the percentage of the
working-age population that is actually working has declined since the
start of the recovery in sharp contrast to 1983-84. With unemployment
still over 9%, there is an urgent need to change course.
Some blame the weak recovery on special factors such as high personal
saving rates as households repair their balance sheets. But people are
consuming a larger fraction of their income now than they were in the
1983-84 recovery: The personal savings rate is 5.6% now compared with
9.4% then. Others blame certain sectors such as weak housing. But the
weak housing sector is much less of a negative factor today than
declining net exports were in the 1983-84 recovery, and the problem
isn't confined to any particular sector. The broad categories of
investment and consumption are both contributing less to growth. Real
GDP growth is 60%-70% less than in the early-'80s recovery, as is growth
in consumption and investment.
my view, the best way to understand the problems confronting the
American economy is to go back to the basic principles upon which the
country was founded—economic freedom and political freedom. With lessons
learned from the century's tougher decades, including the Great
Depression of the '30s and the Great Inflation of the '70s, America
entered a period of unprecedented economic stability and growth in the
'80s and '90s. Not only was job growth amazingly strong—44 million jobs
were created during those expansions—it was a more stable and sustained
growth period than ever before in American history.
Economic policy in the '80s and '90s was decidedly
noninterventionist, especially in comparison with the damaging wage and
price controls of the '70s. Attention was paid to the principles of
economic and political liberty: limited government, incentives, private
markets, and a predictable rule of law. Monetary policy focused on price
stability. Tax reform led to lower marginal tax rates. Regulatory
reform encouraged competition and innovation. Welfare reform devolved
decisions to the states. And with strong economic growth and spending
restraint, the federal budget moved into balance.
As the 21st century began, many hoped that applying these same
limited-government and market-based policy principles to Social
Security, education and health care would create greater opportunities
and better lives for all Americans.
But policy veered in a different direction. Public officials from
both parties apparently found the limited government approach to be a
disadvantage, some simply because they wanted to do more—whether to tame
the business cycle, increase homeownership, or provide the elderly with
better drug coverage.
And so policy swung back in a more interventionist direction, with
the federal government assuming greater powers. The result was not the
intended improvement, but rather an epidemic of unintended
consequences—a financial crisis, a great recession, ballooning debt and
today's nonexistent recovery.
The change in policy direction did not
occur overnight. We saw increased federal intervention in the housing
market beginning in the late 1990s. We saw the removal of Federal
Reserve reporting and accountability requirements for money growth from
the Federal Reserve Act in 2000. We saw the return of discretionary
countercyclical fiscal policy in the form of tax rebate checks in 2001.
We saw monetary policy moving in a more activist direction with
extraordinarily low interest rates for the economic conditions in
2003-05. And, of course, interventionism reached a new peak with the
massive government bailouts of Detroit and Wall Street in 2008.
2009, Washington has doubled down on its interventionist policy. The
Fed has engaged in a super-loose monetary policy—including two rounds of
quantitative easing, QE1 in 2009 and QE2 in 2010-11. These large-scale
purchases of mortgages and Treasury debt did not bring recovery but
instead created uncertainty about their impact on inflation, the dollar
and the economy. On the fiscal side, we've also seen extraordinary
interventions—from the large poorly-designed 2009 stimulus package to a
slew of targeted programs including "cash for clunkers" and tax credits
for first-time home buyers. Again, these interventions did not lead to
recovery but instead created uncertainty about the impact of high
deficits and an exploding national debt.
Big government has proved to be a
clumsy manager, and it did not stop with monetary and fiscal policy.
Since President Obama took office, we've added on complex regulatory
interventions in health care (the Patient Protection and Affordable Care
Act) and finance (the Dodd-Frank Wall Street Reform and Consumer
Protection Act). The unintended consequences of these laws are already
raising health-care costs and deterring new investment and risk-taking.
If these government interventions are the economic problem, then the
solution is to unwind them. Some lament that with the high debt and
bloated Fed balance sheet, we have run out of monetary and fiscal
ammunition, but this may be a blessing in disguise. The way forward is
not more spending, greater debt and continued zero-interest rates, but
spending control and a return to free-market principles.
Unfortunately, as the recent debate over the debt limit indicates,
narrow political partisanship can get in the way of a solution. The
historical evidence on what works and what doesn't is not partisan. The
harmful interventionist policies of the 1970s were supported by
Democrats and Republicans alike. So were the less interventionist
polices in the 1980s and '90s. So was the recent interventionist
revival, and so can be the restoration of less interventionist policy