Back in the Neo-Keynesian Model Jude Wanniski June 17, 1999

Fed Chairman Alan Greenspan's testimony this morning before the Joint Economic Committee (JEC) of Congress propels us back to his state of mind of early 1987 when he was appointed chairman of the Fed. I opposed his appointment then because I had in the previous three years engaged him in a series of discussions about the nature of inflation and economic growth, with Greenspan arguing that an economic recession was necessary to break the back of inflation. Because I was the only person that The Wall Street Journal could locate who opposed the appointment, it quoted me as saying: In every supply-side battle I'd been involved in over the previous dozen years, every time the smoke cleared on the battlefront I could see Greenspan's beady little eyes staring back at me across the trenches. Greenspan contributed in a major way to the stock market crash of October 1987 by telling Fortune magazine that the dollar was overvalued -- in the issue that reached Wall Street the Friday before the Monday crash. Greenspan behaved himself in the years that followed, using the price of gold as a signal of inflationary forces and never again mentioning the need to devalue the dollar. Since the price of gold began its decline in November 1996, he has steadily lost interest in it as a signal of inflation expectations, to the point where Democrats on the JEC today were criticizing his lack of interest in gold as it scrapes lows not seen since 1979.

In the face of these arguments thrown at him by members of Congress concerned that he is trying to stop wages of the lowest income classes from rising, Greenspan's answers were intellectually bankrupt. There are no signs of inflation, he acknowledged, but because we are running out of surplus workers, we have to have a pre-emptive strike. The markets are relieved only to the degree he left the impression it would be a one-time rate increase he would justify when the FOMC meets in two weeks -- not the first of several. The long bond rallied a point but still sits at 6% in a deflation. This still suggests the market knows that as long as Greenspan is in this neo-Keynesian model, he will be forced to permit an inflation when the probable Y2K slowdown hits the U.S. and world economy in six months. He can get away with his gobbledegook about why conditions are different now than they were throughout the rest of human history, to justify a rate hike amidst a painful deflation, because he was deified during the inflation cycle. Why are farm prices so low that farmers are being wiped out? Because farm productivity is so high that we don't need as many farmers, he would say. How come we enjoyed strong productivity growth through the 1950s and 1960s and rapid growth without inflation? Because there was leftover technology from World War II that had not been developed by the private sector, and we don't have leftover technology. What ad hoc nonsense in a world exploding with technological advances not seen since the invention of the wheel.

The neo-Keynesian poison Greenspan is laying down here inevitably spills over into fiscal policy. It is argued that if we are running out of surplus workers, the last thing the President should do is sign legislation cutting taxes! Thus, the Fed would have to raise rates to prevent the inflation that would cause, so we might as well put the budget surplus in a lock box and use it to save Social Security!!! The only tax cut that has a possibility of being signed into law this year is the bipartisan Coverdell-Torricelli "Small Savers Act," which would have powerful non-inflationary supply-side effects. The administration is spreading the word among Democrats in Congress to NOT support the bill, even though it now has the support in the House of the chairman of the Congressional Black Caucus, the ranking Democrat on House Ways and Means, and a growing number of Democratic liberals. The White House would prefer the path the House GOP congressional leadership prefers -- a partisan tax bill the President would veto, albeit one loaded with "Keynesian demand stimuli." The President will be able to argue that the bill the GOP hopes to get to his desk next month will not only raid the Social Security fund, but also push up aggregate demand to the point where the Fed will have to raise rates again. On this path, what we will get out of this pitiful 106th Congress is an increase in the minimum wage. Here, Greenspan was exactly correct in saying the increase will have no adverse effects now, but would balloon teenage unemployment in the next recession. Who cares about teenagers? It is the adults who vote and labor unions who don't want non-union kids stealing jobs from their members.

As far as I can tell, there are no supply-siders making any noise anywhere in the Congress. Senior staff who go to all the relevant meetings tell me nobody even mentions economic growth as a solution to the Social Security problem. Pensions are exclusively debated in the demand model, which of course is static, and requires either tax increases or benefit cuts to bring forth a "solution." In this debate, the Democrats always win, leaving it to the Stupid Party -- as more and more Republicans now refer to their own in private -- to choose between tax increases or benefit cuts. The vaunted Speaker of the House, invisible Denny Hastert of Illinois, was chosen because he is an empty suit, not Newt Gingrich. The Speaker's goal is to keep the trains running on time, which means getting the Appropriation Bills passed before the August recess. The "budget surplus" not spent on tax cuts, which get vetoed, will go to military spending for Balkan wars, Star Wars, and pork-barrel projects over which members of both parties are salivating.

To complain that we are wasting our time, when we should be fixing the system when the economy is on a high, is to be a party pooper. Republicans now are so sure that Texas Governor George W. Bush is the answer to all their prayers that they reassure me all the problems will be solved as soon as he is sworn in 2001. We are running on the fumes of the Reagan era and are assured that George W. will be able to win the White House and Congress for the GOP with "compassionate conservatism." In the June 14 issue of The Weekly Standard, Owen Ullman writes about the man who is going to "define compassionate conservatism" for W. (as Bush is now called). That would be former Fed Governor Larry Lindsey, who is the top dog economist in W's entourage, a Harvard Ph.D. Ullman reminds us: "A tax-policy specialist, Lindsey wrote a staunch academic defense of Reagan's supply-side tax cut in 1990, The Growth Experiment, based on data he collected for his Ph.D. dissertation. But he's no hard-core supply-sider. In fact, his book concludes that a rate reduction pays for itself in the form of higher revenues only when the top rate is 50% or higher. His rationale for a tax cut now is demand-side stimulus -- classic Keynesian economics. Lindsey views the stock market as one big speculative bubble that's bound to burst." When that happens, says Ullman, Lindsey's cure is a two- or three-year cut in marginal tax rates to put money into people's pockets as fast as possible. You may recall that when I first mentioned W's choice of Lindsey as his chief economic architect, I noted that Lindsey was the only economist I've known for a long period of time who has gotten steadily worse with each passing year. I've known his sidekick, Martin Feldstein, for almost 25 years, but he could not be any worse today than he was then. This is the second term of W's daddy coming up, folks, or Bill Clinton's third.

What does this neo-Keynesian renaissance mean? It reflects the dominance in the political culture of the Establishment, which is quite happy with the status quo, with a government big enough to give a profitable return on campaign contributions. It was John Maynard Keynes who devised the theorems to justify big government that stopped just short of socialism. He's back in town and his legion of followers in both parties is telling us, "Don't rock the boat."