Who killed the economic expansion? There is no shortage of suspects. One can start by blaming the Federal Reserve. After a nearly flawless performance guiding the New Economy through breathless takeoffs and soft landings, Fed Chairman Alan Greenspan proved that he is mortal, after all. He extracted one interest-rate hike too many in 1999 and 2000, based on largely groundless fears of inflation. Then, when the economy softened, he waited too long to offer the relief of a rate cut.
Suspect No. 2 is a tumbling stock market. At some point, the market had to return to earth, since stock prices roughly quintupled in the 1990s. The value of stocks can increase at three or four times the rate of growth of the real economy for a few years--but not indefinitely. Prices of technology stocks a year ago were justified only by the "greater fool theory"--the expectation that other giddy investors would bid prices even higher. Once reality intruded, the crash of the dot-com market wiped out trillions of dollars of paper wealth, leaving investors feeling poorer and less willing to spend as consumers.
A third culprit is the hoariest of the usual suspects: the business cycle. Even a technology-driven economic boom matures. Computers have reached near-saturation as a consumer durable. The New Economy is indeed capable of higher sustained growth rates over the long term, but, like any other market economy, it hasn't abolished the business cycle.
Yet another suspect is a contractionary fiscal policy. The current vogue for debt paydown springs from the belief that paying off the public debt gets government out of capital markets and thereby lowers capital costs for private investment. In theory, this stimulus more than compensates for the fiscal drag of endless government surpluses, especially if the central bank cooperates by easing interest rates.
This is questionable economics. Whatever other mistakes he may have made, John Maynard Keynes was correct to point out that prolonged budget surpluses slow an economy by depressing consumption. Keynes would have agreed that a long boom (the 1990s) that follows a period of excessive debt buildup (the 1980s) is a good time to pay down debt. But he would have been appalled at the chorus of economists and politicians calling for endless federal budget surpluses.
As my colleague, author John B. Judis, has observed, the link between the bipartisan deficit reduction deal and the Fed's looser monetary policy has been widely exaggerated. What really occurred is that Greenspan, based on his analysis of productivity data, became convinced that the New Economy was capable of higher rates of noninflationary growth and employment. This prompted the Fed to ease interest rates.
The fact that Congress was also cutting the deficit reassured money markets. But it's time to discard the myth that deficit reduction unlocked lower interest rates, which in turn let loose the boom. What really allowed Greenspan to cut rates in the 1990s was higher productivity growth. And that new productivity reflected long-gestating trends in technology--not in short-term fiscal policy.
ACCESSORY. So who killed the boom? The answer recalls the resolution of Agatha Christie's thriller, Murder on the Orient Express: All of the suspects had a hand in the deed. There's the Fed's overly tight money policy in 1999 and 2000; the stock market coming to its senses; an excessively contractionary fiscal policy; and an ordinary turn in the business cycle. OPEC, which hiked oil prices at an opportune moment, was an accessory after the fact.
Now that the economy is slowing down, it's a good time to rethink fiscal policy. A new policy need not involve the stimulus of George W. Bush's proposed tax cut. It can also take the form of increased public spending. Macroeconomically, we need a stimulus. Politically, there are fundamental choices to be made between tax cuts and valued uses of public outlays--better health care, child development, affordable housing, and education.
Sometimes it's actually good for the economy to incur public debt, both to provide a countercyclical stimulus and to finance necessary public improvements in education, training, and infrastructure. Even in a mild slowdown, government shouldn't be running a surplus. Let's hope it doesn't take a full-blown recession for this revisionist thinking to become respectable again.
Unlike Agatha Christie's murder victim, this economy is far from dead. The good news is that the New Economy really is capable of higher noninflationary growth, if only we have the wit to pursue policies that let the economy realize its potential. That means both an easing of interest rates and a reconsideration of the conceit that we have to pay off the entire national debt.
Otherwise, we will have a very serious recession for which all the suspects can share blame.