Last Friday, I met with a few friends to celebrate the holidays and discuss our thoughts about economic policy decisions made by the Federal Reserve and our Congress.
My friends expressed their concerns about my latest column for the Herald-Tribune, “Why a limited Fed would be good for it and the country.”
In it I supported the views of Philadelphia Federal Reserve president Charles Plosser. He proposed severe limits on our central bank, reducing its discretion and leading it to focus almost entirely on price stability.
My friends said that Plosser’s policy prescriptions would hamstring the Fed so tightly that the central bank could not have taken the extraordinary actions that saved our nation from descending into a depression in 2008. In brief, the Fed provided trillions of dollars in guarantees and loans to maintain liquidity in the system. My friends pointed out that, with the gridlock in Congress, only the Fed could take the appropriate remedial actions. In retrospect, I think their arguments have merit. I would now say that many of the Fed’s actions were dangerous, but necessary.
I feel on stronger ground, however, in urging the Fed to reduce its bond purchases further. On Wednesday it trimmed its bond buying by $10 billion a month, to $70 billion, citing improvements in the U.S. economy.
The U.S. economy should grow nearly 3 percent in 2014, an acceptable rate for a developed country. Unless economic growth drops significantly, the Fed can afford to be neutral — neither buying nor selling securities.
When the conversation turned to fiscal policy, I expressed my frustration that Washington has turned a deaf ear to the nonpartisan Congressional Budget Office, which has warned repeatedly that the federal budget is on an unsustainable path. While the budget deficit has dropped from $1 trillion annually to about half a trillion, even these shortfalls are not sustainable.
The budget agreement reached between House Budget Committee chairman Paul Ryan and his Senate counterpart, Patty Murray, seeks to provide stability to Congress’ fiscal policymaking over the next two years. It avoided another government showdown, set spending levels and reduced the deficit. Specifically, it rolls back sequestration cuts to education, medical research, infrastructure investments and defense jobs for the next two years. It does not take steps to ensure the long-term viability of Medicare, Medicaid or Social Security.
The bipartisan budget compromise provides very small savings, some $23 billion. These saving are tiny compared with the federal government’s total debt. According to the Treasury Department, total debt stood at $16.7 trillion as of Sept. 30. This slightly exceeds current gross domestic product, which measures our nation’s output of services and goods.
Net interest payments on our debt are $222 billion, some 6 percent of federal outlays. Our current low interest costs result primarily from very low interest rates. Under a normal interest- rate scenario, our net interest costs could rise to more than 20 percent of federal outlays. Under this scenario, the government would need to cut its spending dramatically, causing hardships far beyond the current sequester.
To achieve a balanced budget now would require raising revenues or cutting expenditures by more than 20 percent. In 2012, revenues were $2.9 trillion and expenditures were $3.8 trillion. To accomplish meaningful budget reductions, we must consider across-the-board tax increases and meaningful entitlement reform. Hopefully, we can build on the Ryan-Murray bipartisan efforts.
Many people feel upbeat because of the 25 percent market surge in 2013. It made us giddy. I am reminded, however, of a story told by my guide to Versailles several years ago. Louis XIV built it. Louis XV enjoyed it, Louis XVI paid for it. With his head.
Originally published in the Sarasota Herald-Tribune
