A Spark From Treasury Could Fire Up The EconomyKaren Pennar and Christopher Farrell
It's a tired refrain we keep hearing from Washington: The economic recovery is being held hostage to politics and a yawning budget deficit. To apply defense savings elsewhere in the economy, last year's budget agreement would have to be reopened. To enact tax cuts, offsetting savings would have to be found. But is policy really so paralyzed? Perhaps not.
Without even entertaining congressional debate, there are some things that the U. S. Treasury and banking regulators could try to get the economy moving.
First, the government could shorten the maturity of its debt. Inflation has come down under 4%, and short-term interest rates are at their lowest levels in 15 years. Today, three- and six-month Treasury bills are yielding less than 5%, and five-year notes are paying 6.63%. The 30-year long bond, meanwhile, is yielding around 7.9%. That reflects an inflation premium paid investors because they fear inflation will rise.
SPENDING BOOM. The Treasury should tell the world that it believes prices will remain stable by announcing that it will issue mostly short- and medium-term debt, and sticking to that. What would happen? Long-term rates would fall, providing needed stimulus, and the interest bill on future debt would shrink. "Long bonds would go to 7% almost overnight," says William H. Gross, managing director at Pacific Investment Management Co., which manages $35 billion in bonds. "It would be a shot heard around the world." Joseph Rosenberg, chief investment officer of Loews Corp. in New York, suggests that Treasury substitute four- to five-year notes for 30-year bonds at its quarterly refundings, thereby saving taxpayers at least $500 million in interest costs annually. Rosenberg, who urged the Treasury to take such a step in a recent article in The Washington Post, says the "real beneficiary of all this would be the U. S. economy." Lower long-term rates would unleash a rush of mortgage lending and a capital-spending boom.
The Treasury's action could be reinforced by the Federal Reserve Board, which could instruct its traders in New York to buy up the highest-yielding, longest-dated bonds in the course of their market dealings. "I think it would be a wonderful step," says economist James K. Galbraith of the University of Texas at Austin. "Keynes says about the most useful thing a central bank can do in a recessionary environment is purchase long-term debt."
While acting forcefully to lower rates, Washington could also get banks lending again. Profit-pinched banks have been loath to pass lower rates on to their customers. At the same time, banks are so busy writing off mistakes of the 1980s that they are unwilling to risk making new ones. Finally, regulators have pressured banks to build up capital and be cautious.
One quick, painless, and not very costly way to boost bank profits would be for the government to pay interest on more than $20 billion in idle reserves that banks keep to back up deposits. David D. Hale, chief economist at Kemper Securities Group Inc. in Chicago, says that if banks were paid the current T-bill yield on reserves, it would boost their profits by more than $1 billion. If they were paid interest on reserves, he argues, banks wouldn't feel compelled to earn profits by keeping their prime lending rate so high.
Interest on reserves might help, says Albert M. Wojnilower, senior adviser at First Boston Corp., but there are plenty of banks that are already profitable. Instead, he argues, banking regulators should impose broad growth targets for bank loans and other assets and ensure that banks meet those targets. "Banking is like a utility," he says. "You expect an electric company to generate electricity."
LOUD AND CLEAR. These ideas aren't entirely new, and they've had a mixed reception in the past. The U. S. Treasury, which sold $1.5 trillion in securities last year, has long held to the view that the smooth functioning of the government securities market requires that investors be able to choose from a predictable and broad spectrum of maturities. Some Reagan Administration officials floated the idea of shortening debt maturities in 1981, but they got nowhere. In the early 1960s, the Fed tried to bring long rates down by buying up long bonds in the open market, with limited impact. And even the force of law, embodied in the Community Reinvestment Act, hasn't prevented bankers from discovering ways to cut off some borrowers.
There are no guarantees that what investors and lenders fear -- a return of inflation and a new cycle of bad loans -- won't come to pass. Periodic spikes in prices, such as October's 0.7% jump in producer prices, only fan such worries. But there is a better chance of success if the government commits itself to low inflation and low interest rates with a policy that is loud, clear, and sustained. The aim is to change expectations and thereby boost confidence, spending, and borrowing. It won't happen overnight, and it won't happen if the government says one thing and does another. But inaction won't get the economy off dead center. These relatively easy measures just might.