What’s in Our Wallet?

Last year Paul O’Neill decided he wanted to address the American Economic Association meetings in Washington this week on the topic of “Using Economics to Improve Public Policy.” O’Neill was Treasury Secretary, so he got what he wanted: top billing on the first day.

His office lined up three Nobel laureates to comment on what he would have to tell the assembled throng — Berkeley´s Daniel McFadden, the University of Chicago’s Gary Becker and Robert Lucas. And AEA president-elect Peter Diamond of the Massachusetts Institute if Technology agreed to moderate the discussion.

Alas, we’ll never know what O’Neill had in mind. After he was fired last month, the Administration declined to put up another speaker to take his place. The laureates pulled out, and Diamond had to quickly line up another panel, consisting of Alan Auerbach and Janet Yellen of the University of California at Berkeley, Eric Engen of the American Enterprise Institute, Robert Hall of Stanford and Matthew Shapiro of the University of Michigan.

When they met Friday, the five valiantly tackled their newly-assigned topic — what sort of fiscal stimulus, if any, was warranted in the current situation? Engen argued the widespread view that, based on conventional measures such as decline in output and peak unemployment (apparently 6 percent), the business contraction that may have ended a year ago had been “the mildest recession of the post-war period.” It was reasonable to expect that the recovery should start out mild as well, he said.

Hall, who is a member the committee that dates the peaks and troughs of the business cycle for the National Bureau of Economic Research, disagreed, saying that from the standpoint of job creation, the recession had been “typical, not mild.”

Productivity gains were the reason that the economy grew at a recorded rate of around 3 percent last year, said Hall. Total jobs had scarcely grown at all for nearly 18 months, and that was the main reason that the NBER had yet to declare the recession over.

Yellen, a former chief economic adviser to President Clinton and former governor of the Federal Reserve System, agreed. The economy was “extraordinarily fragile,” she said. The Fed’s own economists were uncertain that monetary policy could be made to serve if things got worse, for whatever reason. “A vaccination, and insurance policy of some sort” was clearly indicated.

But it was Auerbach who sounded the most somber note. “I don´t see how you can adopt a long-run tax cut without saying where the long-term revenue balance is going to come from.”

Indeed, for all the talk about short-term stimulus — President Bush is scheduled to propose a $300 billion, 10-year accelerated tax cut plan on Tuesday — the really interesting question went all but unaddressed at the fiscal policy sessions. Perhaps it was what former Treasury Secretary O’Neill had planned to broach. After all, one of his deputies, Undersecretary Peter Fisher, had brought it up in a speech last autumn in Columbus, Ohio.

How, asked Fisher, will the government in the 21st century keep the promises made in the 20th century?

Berkeley´s Auerbach has been among the most persistent students of the sharp deterioration in the nation´s fiscal balance over time. It is mostly the result of steadily growing Social Security and Medicare and Medicaid obligations, though rising defense spending and projected tax cuts play a part as well.

The fiscal gap is expected to be 4-8 percent of gross domestic product per year, for many years into the future. Tax increases totalling 20 percent of GDP would be necessary to close it, Auerbach said. And since the federal government´s entire tax take today is less that 20 percent of GDP, taxes effectively would have to double in order to make good on today’s promises — or those promises would have to be cut by a corresponding amount.

For that reason, perhaps the most invigorating proposal circulating in senior policy circles wasn´t to be found on the docket of the AEA meetings at all. Its most recent form, it was broached by Stephen Cecchetti, former director of research at the New York Fed, in an article in the Financial Times last month.

The government needs a comprehensive new fiscal policy framework, comparable to inflation targeting, Cecchetti argued.

“Early attempts have misfired,” he wrote, “but it is important that we redouble or efforts now.”

The idea that the government should estimate the net-present-value of its unfunded obligations over a 75-year or so horizon is hardly new, as Cecchetti acknowledged. Fed chairman Alan Greenspan plumped for accrual-based accounting in Congressional hearings last year. The same sort of reasoning underlay the now-lapsed Budget Enforcement Act.

Yet legislators’ temptation to avoid estimating price tags for benefit programs is very great. It is roughly comparable to central bankers’ tendency to use easy money to purchase fast growth and political advantage during the high-inflation years.

“We need to achieve fiscal discipline that ties fiscal policy-makers’ hands, just as a price stability objectives tie the hands of monetary policy makers,” wrote Cecchett, drawing an analogy with the extensive investigation of commitment in monetary policy of the last twenty years.

To get things started, he wrote, “We should restrict federal government revenues to the 40-year average of 19 percent of GDP and estimated public debt should not rise above 50 percent of GDP. All current and future tax or spending proposals should be evaluated relative to this objective.”


Cecchetti is a specialist in monetary policy. He has taught economics at Ohio State University before and after he ran the research department for the New York Fed. Next autumn he will move to Brandeis. Technically speaking, he has no business telling his fiscal policy brethren what they should be thinking about. But sometimes the sharpest ideas come from outsiders to the guilds of those who are professionally responsible for fashioning the consensus. It then becomes the work of many years to put the new idea on the agenda.

Was such an idea on the mind of former Treasury Secretary O’Neill? It doesn´t matter. Such reforms rarely come from the top. Nor should the Bush administration’s general absence from the economic meetings be taken as a sign that it doesn’t take its economic policy seriously. (Treasury Undersecretary for International Affairs John Taylor describe the administration’s policy on global financial stability and growth in one of the three major lectures on the program.) For a closer look at Bushonomics, wait until next year — when president-elect Martin Feldstein arranges the AEA program.