A Divided Economic Policy Cannot Stand
What a difference a month makes.</br></br>In July, consumer confidence reached a 29-year high, the Dow Jones Industrial Average was at an all-time high, unemployment rates plumbed 28-year lows, and the dollar grew stronger against virtually every currency on earth. By late August consumer confidence was down, as was the dollar, and a growing number of economists were forecasting recession in 1999. Yet no sooner had the doomsayers spoken then the Dow rebounded and the economic outlook brightened once again.</br></br>Volatile markets will always be with us. But what's of real concern is the increasingly volatile and self-contradictory nature of our economic policies. The Federal Reserve, shifting abruptly from the inflation front to the recession front, has cut short-term interest rates by half a percentage point and revved up monetary growth rates beyond nearly all targeted growth ranges. Yet undermining this new tack are constrictive fiscal policies -- higher taxes and burgeoning regulations -- which virtually guarantee that output cannot keep pace with the money supply. If previous business cycles are any guide, the result will almost certainly be a return of inflation and the end of the steady-growth economy.</br></br>Fiscal and regulatory policies today are particularly burdensome. Taxes consume 42% of personal income, and regulations cost 10% of gross domestic product. The federal tax code has grown from 11,400 words when it was conceived in 1913 to 555 million words today. Last year's Taxpayer Relief Act, which like so many of its predecessors was billed as a tax-code simplifier, actually created 824 amendments and added 285 new sections to the existing code. It requires an estimated 60 million hours of extra work by taxpayers, creates 18 new tax forms and revises 230 existing forms. As Mark Twain said, "History may not repeat itself, but it sure rhymes."</br></br>What measures might be taken to synchronize fiscal and monetary policies into a pro-growth, price-stabilizing mode? Years ago, Milton Friedman recommended putting the Fed on automatic pilot, meaning that it should create money at a steady rate of 3% to 5%, consistent with the estimated long-term growth potential of real output. In revisiting this guide, it is especially helpful to recall that in its 84-year history the Fed has tended to be reactive rather than pre-emptive. Its sudden midcourse corrections have merely amplified the swings of the business cycle.