Weekly Standard Online
April 9, 2011
by Irwin Stelzer
Whatever coordination existed between policymakers immediately after the world's economic crisis is no more.
Start the policy tour with China. The regime's leaders, worried about accelerating price increases that have taken the inflation rate to about 5 percent, have raised interest rates four times in five months. The one-year lending rate now stands at 6.31 percent, which the regime hopes will prevent the unrest caused by rising food prices without triggering the unrest that would follow if the economy slowed too much, creating a large reserve army of unemployed labor.
On to the eurozone. Jean-Claude Trichet, head of the European Central Bank, fears that a rise in prices of Chinese imports will further increase inflation rates in the eurozone, already above his target of less than 2 percent, and has begun raising rates. Groans from Lisbon, Dublin, and Athens matter less than cheers from inflation-phobic Germany: it is unreasonable to expect everyone to squeeze comfortably into the one-size-fits-all interest rate of the 17-nation eurozone.
Then to Latin American and the international agencies, where more inflation hawks roost. Several Latin American central bankers are raising interest rates, while economists at the International Monetary Fund have done volte face, and are now urging developing countries to impose capital controls to prevent the inflow of hot money that has historically triggered inflation.
The Anglo-Saxons see things differently. Both Mervyn King, governor of the Bank of England, and Ben Bernanke, chairman of the Federal Reserve Board, believe the price spurt in the commodities market will play itself out in the next several months, and that inflation will again subside. Besides, an emerging recession in Britain, King figures, and tepid job growth in America, Bernanke figures, demand low interest rates and the continued printing of money, with the result that Captains King and Bernanke continue to sail forward on their separate sister ships, QEUK and QE2USA, despite complaints from some crew members that they are steering their economies into rough inflationary waters. The minutes of the March 15 meeting of the Fed's monetary policy committee note, "A few participants indicated that economic conditions might warrant a move towards less- accommodative monetary policy this year." And Narayana Kocherlakota, president of the Minneapolis Federal Reserve Bank, thinks interest rates should go up 75 basis points (¾ of 1 percent) by year-end, a view shared by several private sector economists. Not quite a mutiny, but neither is it a vote of confidence in the captain.
U.S. and UK monetary policies might be similar, but fiscal policies definitely are not. George Osborne, Britain's chancellor of the Exchequer, has decided that taming the deficit over the next four years is essential to keeping the bond vigilantes, who have wreaked havoc with the economies of Greece, Ireland and Portugal, at bay. So far, so good: Britain retains its triple-A rating, and the slower or nil growth resulting from lower spending and higher taxes has not produced politically unmanageable outcries. At least, not yet.
In America we have checks and balances, rather than parliamentary dictatorship. The president proposes, Congress disposes. The result is a war between a Republican-controlled House of Representatives intent on rolling back taxes, spending, and the size of government, and a Democratic-controlled Senate and White House intent on maintaining or even increasing spending, and raising taxes.
It is this difference, plus disagreement over just what is to be cut, rather than the tiny sums involved -- perhaps ¾ of 1 percent of the $3.8 trillion the government is projected to spend in the current fiscal year -- that caused the impasse that nearly resulted in a shutdown of non-essential government agencies on Friday. This battle was made inevitable when the Democrats, then in control of both chambers of Congress, refused to approve their president's proposed budget for the fiscal year beginning September 1, 2010 because too many Democrats feared his plan for continued high spending and unsustainable deficits would spell disaster at the polls. In the end, even though it failed to win congressional approval, many of the Democrats who thought they could hide behind a refusal to vote for the Obama budget were returned to the private sector, replaced by Republicans who pledged to cut spending and the size of government.
That battle over how much the government can spend in the remaining six months of this fiscal year is a mere skirmish compared to what is to come. Wisconsin Republican congressman Paul Ryan, who chairs the House Budget Committee, has thrown down the gauntlet with a plan to cut $179 billion from the 2012 White House budget and another $241 billion in 2013, part of spending cuts that would total $5.8 trillion over the next ten years, and reduce projected deficits by $4.4 trillion. Since the president is calling for an increase in spending, the Ryan plan comes in at $6.2 trillion less than the Obama proposal. If Ryan, who quite rightly says, "America is facing a defining moment," has his way, the deficit will drop from close to 10 percent of GDP to 1.6 percent by 2021, and the government's share of a larger GDP from the 24 percent Obama projects to about 20 percent, its historic average.
Because Ryan's plan calls for an effective replacement of the government-run health care system with subsidized private insurance, Democrats are certain that the Republicans have sunk their chances of gaining ground in the 2012 elections. Which reminds Washington Post columnist Charles Krauthammer of the 1983 elections in Britain, when a colleague characterized Labour Party leader Michael Foot's election manifesto as the longest suicide note in history -- at the peak of the Cold War Foot called for unilateral nuclear disarmament to set an example the world would follow. Krauthammer calls the Ryan plan, which he broadly favors, the longest annotated (37 footnotes) suicide note in American political history.
An unfortunate effect of the Ryan plan, an intended or unintended consequence, depending on your degree of cynicism, might be its derailing of an emerging consensus that was forming around the plan put forward by the president's bipartisan deficit reduction commission, chaired by Alan Simpson and Erskine Bowles. Ryan and the commission call for roughly similar reductions in the deficit. But Ryan's deficit reductions come from spending cuts, whereas the commission's allows for some revenue enhancements, aka higher taxes. Republicans inclined to support Simpson-Bowles will now have to explain to their constituents, many of them Tea Partiers, why they aren't backing the more ideologically consistent Ryan Plan.
The good news is that the contours of a bargain are shaping up: the Republicans back down from Ryan's plan by accepting Democrats' demands for some tax increases and fewer spending cuts. The resulting level of spending, while higher than at present -- not unreasonable, given the ageing of the population -- leaves the government claiming about the same percentage of a larger GDP as it claimed before the Obama spending spree, instead of the Obama target of 24 percent, a level that can be sustained only with much higher taxes. Those of us who remember Irving Kristol's observation that massive cuts in the welfare state are simply infeasible, and that conservatives should confine themselves to reducing the relative role of government by growing the private sector, will have some sympathy with that result, if indeed it comes about.
Any Democratic-Ryan compromise might have to wait until the voters have spoken in 2012, if the markets don't force an earlier deal by driving interest rates up. Obama will surely want to see if attacking the Republicans for shredding the social safety trumps Republicans' claims that we are on the road to Greece, Ireland, and Portugal if we don't curtail entitlements. He has reason for optimism -- two reasons in fact. The first is that the Republican field is hardly awe inspiring. More important, two-thirds of respondents to a Pew poll say they oppose any changes to Medicaid and Social Security, the latter untouched by Ryan which, says Krauthammer, "proves only that Ryan is not completely suicidal." When it comes to spending cuts, most Americans live in a NMBY world.
Meanwhile, the real action will be on the monetary policy front, where Bernanke is running into a bit more opposition to continuation of his zero-interest rate policy than he has confronted in the past. But not enough to deter him from his easy money policy, and from seriously considering launching QE3 when QE2 is drydocked at the end of June. After all, he is responsible both for preventing inflation and producing full employment. Satisfying two such different and demanding mistresses must be wearying indeed.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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