Greenspan And Clinton Could Play Some Snazzy Duets

Undoubtedly, the most remarkable link between President Bill Clinton and Federal Reserve Board Chairman Alan Greenspan is the saxophone. In the 1940s, Greenspan earned a living wailing away with the Henry Jerome band at Childs' Paramount restaurant in New York City. The question now arising, especially in the financial markets: Will Clinton and Greenspan make beautiful music together on economic policy?

Chances for a surprising amount of harmony between the Democratic White House and the Republican Fed are rising. The common theme is deficit reduction. A specific "deal" to swap deficit cuts for lower interest rates, hinted recently, is probably a stretch. However, if the Administration shows that it is truly committed to stemming the flow of red ink--by fashioning a long-term, ironclad package--the Fed clearly will be less inclined to raise rates than it would otherwise be as the expansion builds.

Greenspan was careful to give at least the appearance of accommodation during his congressional testimony on Jan. 27. "Cooperation is already accelerating between myself and other members of the Federal Reserve Board and the new Administration," he said. What that means in policy terms, however, is yet to be seen.


So far, Clintonites such as Treasury Secretary Lloyd M. Bentsen are hitting all the right notes on the necessary "sacrifices," including talk of an energy tax. Also, they are committed to only a small dollop of pump-priming, $15 billion to $20 billion, for fiscal 1993. Besides, some of that stimulus will be offset by this year's smaller tax refunds, resulting from last year's cut in the amount of taxes withheld from workers' paychecks.

One reason for such a modest stimulus package is that the economy may not need it. In particular, the latest word from consumers is that they feel more bounce in the economy (chart). Although the Conference Board's index of consumer confidence edged down slightly in January, to 77, after two strong gains, households gave a decidedly more favorable assessment of prevailing conditions for the third consecutive month. And most important, the board reported a fairly large decline in the number of people who say that jobs are "hard to get."

All this has not escaped the attention of the bond market, which is in constant fear of the potential inflationary consequences of $300 billion yearly deficits through 1997, as recently projected by the Bush Administration. The latest numbers from the Congressional Budget Office look even worse; CBO Director Robert D. Reischauer called them "grim" in testimony on Jan. 26.

The bond rally on Jan. 25, on the heels of Bentsen's hawkish words on deficit-cutting, pushed the yield on 30-year Treasury bonds to a six-year low of 7.19%. Also fueling the rally: growing speculation that the Treasury will sell fewer 30-year bonds. And the cardinal bond-market fundamental--inflation--looks fabulous, especially in light of moderate economic growth, productivity gains, and the slow pace of labor costs that was evident in the government's latest employment-cost index.


The bond market will provide the best clues to how Clinton and Greenspan are getting along, because the market and the Fed share the inflation worries associated with the deficit. That's why long-term interest rates are so unusually high relative to short-term rates.

Historically, long rates have averaged about 3% above the inflation rate. So, with inflation at 3% currently, long rates should be closer to 6%, not greater than 7% as they are now. The difference: The market has built in a deficit premium to cover the added inflation worry.

The bond market seems to be telegraphing a further sizable drop in long-term interest rates if the Administration can prove that it can pull off, simultaneously, more spending on various types of investments and credible deficit reduction. But that's still a big "if."

The dialogue on spending cuts has not even begun, and reining in outlays will be key to Clinton's success (chart). Greenspan urged that any lasting deficit reduction must be concentrated on the spending side. "Unless you bring down expenditures," said the Fed chief, "you have to increase taxes every year."

To that end, White House Budget Director Leon E. Panetta has said that the Administration plans to cut $2 in spending for every $1 in new taxes. That could be tough. The Bush projections, which understate the problem, show that by 1997 three rapidly growing, mandatory items will account for nearly 60% of all outlays: health care and Social Security, which are politically sensitive, and interest on the national debt.

The real Bill Clinton will finally stand up on Feb. 17, when he outlines his economic plan in the State of the Union address. The numbers will have to add up by mid-March, when Clinton is expected to submit the details of his fiscal 1994 budget.


The big question for the outlook, of course, is how the policy jam sessions along the Potomac will resonate eutside the Beltway. Higher taxes and some entitlement cuts will temper consumer spending. However, a deficit-reduction package that eases inflation fears and lets some air out of long-term interest rates would further lighten the debt burdens of consumers and businesses. And it would be a plus for home buyers.

Even without a deficit plan, the inflation picture for 1993 was already glowing because of the subdued pace of demand and the downward tilt of labor costs. Employment costs in private industry rose by 0.9% in the fourth quarter. Over the past year, wages and benefits have risen just 3.5%--the smallest gain in five years (chart).

Weak labor demands have enabled companies to keep a lid on pay hikes. Wages and salaries rose by 2.6% for 1992, down from 3.7% in 1991. The drop in wage growth, along with the recent gains in productivity, suggests that the labor cost of producing a unit of output in 1992 grew at the slowest rate in 27 years. Unit labor costs in 1993 should remain equally tame--a key reason for the excellent inflation outlook.

Not surprisingly, given the publicized staff cuts among big corporations, white-collar workers are bearing the brunt of the downshift in labor costs. Salaries of executive and managerial occupations rose by just 1.6% in 1992. That's down from 4.2% for 1991, and even below the 2.6% pace of blue-collar wages in 1992.

At the same time, companies are trimming the growth of benefits. Benefits for private-industry workers rose 5.2% in 1992, down from their peak of 7.1% hit three years ago. According to the Labor Dept., the slowdown in pay is causing a similar drop in benefits tied to wages. Plus, medical-insurance costs have decelerated because companies are either dropping health benefits entirely or shifting premium payments to workers.

Low inflation will help drop the floor beneath long-term interest rates. That, plus the expected rise in incomes, suggests that the housing upturn will continue into its third year.

Housing ended 1992 on a high note. Housing starts increased by 5.5% in December, to an annual rate of 1.3 million. Single-family starts rose for the fifth straight month, advancing by 3.7% to a 1.13 million pace, the highest level in nearly three years (chart). In addition, sales of existing homes increased by 5% in December, to a shade over 4 million at an annual rate, the highest pace since mid-1979.

Cheaper mortgages and better vibes from the economy are rousing home buyers. The fixed rate on a 30-year mortgage was 8.35% in December and slipped to 8.09% in the week of Jan. 22, according to HSH Associates.

Mortgage rates, and long rates generally, could fall even further this year if the White House proves to be in tune with the Fed on the matter of deficit reduction. If so, Clinton, with Greenspan's help, might just be able to jazz up this economy in 1993--and beyond.

Before it's here, it's on the Bloomberg Terminal.