Greenspan Stands Alone

SYNOPSIS: Only one man can save us now

There are three great economic powers in today's world -- the United States, Europe and Japan. In principle, each of these has two potent recession-fighting tools at its disposal. One is monetary policy: the central bank can print money and drive down interest rates. The other is fiscal policy: the government can try to support a flagging economy by cutting taxes and increasing spending.

In practice, however, almost the entire burden of fighting what has become a global slowdown is being borne by U.S. monetary policy. And you have to wonder whether the Federal Reserve, acting on its own, can really do the job. Why does the Fed stand alone? Start with Europe. In terms of sheer purchasing power, Europe is America's equal; now that most European countries have adopted a common currency, managed by a single central bank, you might expect Europe and the United States to be twin pillars of global economic stability.

But the institutions of Europe's Economic and Monetary Union were designed to fight the last war -- they constitute a Maginot Line protecting the Continent from inflation, but make it almost impossible to respond to economic threats that come from a different direction. In particular, the charter of the European Central Bank requires it to defend price stability -- full stop, end of sentence. And bank officials have disavowed any responsibility for growth and employment.

What about fiscal policy? European countries don't have much room for maneuver, given large public debts and the looming burdens of an aging population. And whatever room for maneuver they might have had was taken away by Europe's Economic Stability and Growth Pact, which prevents even temporary deficit spending. Hesitant suggestions by some finance ministers that these rules be relaxed have been harshly criticized by the central bankers; so European fiscal action to fight a slump is pretty much out of the question.

Then there's Japan. After years of immense spending on public works, Japan has a debt of 130 percent of G.D.P. -- and it, too, has an aging population. So it can do no more by way of fiscal policy; in fact, retrenchment is the order of the day.

At the same time, conventional monetary policy has reached its limit in Japan, since short-term interest rates are already zero. The Bank of Japan could do more, if it was willing to adopt unconventional measures, like targeting a positive rate of inflation -- a course of action supported by some of Prime Minister Junichiro Koizumi's advisers. But Japan's central bank has refused to make any significant moves in that direction. And Mr. Koizumi's own finance minister has denounced calls for radical monetary policy, warning of runaway inflation even as his country slips into a deflationary spiral.

And then there's us. What are we doing to fight the slowdown?

America does, of course, have its tax cut. But the peculiar "back-loaded" timing of that cut makes it a very poor recession-fighting measure. The rebate checks are not much more than pocket change -- $40 billion, or 0.4 percent of G.D.P. The big tax cuts, which will eventually rise to almost 2 percent of G.D.P., won't come until the middle of the decade. And the decision to lock in trillions of dollars in future tax cuts actually depresses the economy now, since those future cuts do little to encourage current consumer spending but do raise long-term interest rates.

Can we pump up the economy with additional tax cuts or temporary public spending? Not safely; those huge future tax cuts have created a grim long-term financial outlook, and any further tax cuts would make the outlook even grimmer. Of course, the administration might do the responsible thing, making room for additional tax cuts now by canceling some of those big tax cuts scheduled for 2004 and later. And pigs might fly.

It's a dismal picture: a combination of intellectual confusion, narrow-minded officials and sheer fiscal folly has removed most of the tools that the world's major economies might be able to use to help us get through these troubled times. The only institution that isn't paralyzed is the Fed, which keeps on cutting rates, hoping that it will finally accomplish something. Or to change metaphors a bit, the whole burden of avoiding a global recession now rests on Alan Greenspan's shoulders.

Presumably Atlas won't shrug. But what if the task is beyond his powers?

Originally published in The New York Times, 8.31.01