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24 IRET Congressional Advisory 1 (1993)

handle is hein.taxfoundation/iretcgadv0023 and id is 1 raw text is: August 4, 1993 No. 24 ASK NOT WHAT THE FED CAN DO FOR YOU Several Members of Congress are all a-twitter over recent testimony by Federal Reserve Board Chairman Alan Greenspan and Governor Wayne Angell. Both suggested that the Fed could not offset the anti-growth consequences of the Budget Reconciliation package by easing monetary policy. The Members are acting as if the Fed is breaking some sort of trade agreement: We'll tighten fiscal policy if you ease money. The Members are alarmed (read scared) that they may be fficit held responsible for the slower would not ba economic growth that the tax- and the Pres and-spend policies will could not...TI produce, and concerned (read cannot offst angry) that the Federal afiscal policy Reserve is refusing to bail money. them out. The Members are still playing the old game of rearranging the fiscal- monetary mix, which is akin to rearranging the deck chairs on the Titanic. The Federal Reserve, however, has given up such ineffective pursuits. Note that the testimony of the Federal Reserve officials was not that they would not bail out the Congress and the President, but that they could not. The Federal Reserve does not control interest rates as assumed by the fiscal-monetary mix mongers. The mix mongers are mixed up. Greenspan stated that there is no room for Federal Reserve easing with short term interest rates barely above the rate of inflation (virtually zero in real terms). Short term rates are actually negative after taxes. Others have observed that long term interest rates, after taxes, are not much above the current inflation rate either. These observations are badly phrased. Interest rates can go as low as zero in nominal terms. (But not lower; no one would pay to give money away.) There is no reason, however, why interest rates cannot be negative in real after- tax terms, so long as holding cash is even less attractive after inflation, and the real after-tax-and- regulation returns on additional plant and equipment are next to nothing. The real reason that the Fed cannot ease further is that faster money growth would raise concern about inflation and y o f the Federal us was not that they il outt the Congress dent, butt that they ~e Federal Reserv~e real events, sutch ais blutnder, by printing raise, not lower interest rates, and raise, not lower, the cost of capital and the cost of production. The Federal Reserve cannot offset real events, such as a fiscal policy blunder, by printing money. If an act of God cuts output, or a less- than-divinely-inspired tax or regulation raises the real cost of producing real goods or services in the private sector, there is nothing that the Federal Reserve can do about it. Suppose a drought or a flood destroyed half the wheat crop. Could printing more money replace the lost wheat? Suppose the EPA required all cars to be made with $600 catalytic converters, and the higher price reduced car sales. Would printing money cut the cost of other auto parts by an offsetting amount? Suppose a gasoline tax hike raised the cost of gasoline to the consumer. Could cars burn Institute for Research on the Economics of Taxation IRET is a non-profit, tax exempt 501(c)(3) economic policy research and educational organization devoted to informing the public about policies that will promote economic growth and efficient operation of the free market economy. 1730 K Street, N., Suite 910, Washington, D.C. 20006 Voice 202-463-1400 * Fax 202-463-6199 0 Internet www.iret.org

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