Thomas Hoenig, the only central banker who STEADILY called for a return to real business and honest economics, has given a speech where he describes the problem and prescribes the solution. PRECISELY CORRECT ON BOTH ENDS.
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The question is, can we reverse these trends? Of course we can. But will we? Doing so will require that we discipline our impulse to spend ever-greater sums, accumulate massive debt, and print dollars to buy the debt. This will not be painless. Solutions require good policy, not merely good intentions. So, what might that policy be?
First, Congress must get its houses in order and bring its budget into better balance. Whether that means spending cuts or tax increases, or a combination of the two, lawmakers must choose to act. This will require study and compromise. The United States has done this twice since the end of World War II. At the end of that war in 1945, our debt was 120 percent of GDP. Over the next two decades it was brought down to near 30 percent. As recently as 1996 to 2000, a Republican House of Representatives and a Democratic President literally balanced the budget and brought the debt-to-GDP ratio back below 55 percent. What’s most impressive is that real GDP growth was approximately 4 percent in each of those years. Once businesses and consumers were confident that policymakers were committed to a sound budget, to be achieved in a cautious but deliberate manner, the economy prospered. This is not a state secret. It’s possible.
Second, the Federal Reserve should retire QE except temporarily during the most severe economic crises, as it was intended to be used. The Federal Reserve’s mission is to “promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Too little attention is paid to the long-run part of the mandate and the discipline demanded to achieve it. Too often the Federal Reserve acquiesces to the notion that “it is the only game in town” to justify its money printing as a substitute for Congressional action. The Federal Reserve has made it easy for lawmakers to avoid their responsibilities, becoming the enabler to a famously gridlocked Congress. The Federal Reserve should not be a market maker—the dominant buyer—of our national debt as an ongoing policy tool. This choice distorts the market and invites asset and price inflation.
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The Federal Reserve CAN implement the solution, and it already IS implementing the solution. Staying the course might be difficult, but given the immediate record it’s not impossible.
Congress is NOT capable of doing anything at all. Hoenig’s two examples of the right response are illuminating. As a KC man, Hoenig is close to Truman’s life and record. In the speech he talks about Truman working with the recalcitrant Repooflicans in Congress to get it done. The ’96 example of Clinton working with Newt is within living memory, but I doubt that it could happen now. Congress is TOTALLY USELESS now. All it does is block and halt. Congress was slightly more functional in ’96.
Overall Hoenig is simply following Keynes. Keynes proposed using gov’t spending like a dam. In good times, overtax and underspend to store up a reserve. In a drought, cut taxes and spend the reserve to water the economy. Politicians ignore the first part and only follow the second part. They are incapable of overtaxing or underspending.
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