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SHADOW OPEN MARKET COMMITTEE
(SOMC)
Policy Statement and Position Papers

March 7-8,1993

PPS

93-01

BRADLEY POLICY
RESEARCH
CENTER

Public Policy Studies
Working Paper Series

W I L L I A M

SIMON

GRADUATE SCHOOL
OF BUSINESS ADMINISTRATION

U>mraSITYOFR(XHESTER
ROCHESTER,

NEW

YORK

14627

Shadow Open Market Committee

TABLE OF CONTENTS

Page
Table of Contents

SOMC Members

SOMC Policy Statement Summary

Policy Statement

The Uruguay Round and Free Trade Areas
Jagdish Bhagwati

Federal Reserve Independence and Accountability
W. Lee Hoskins

President Clinton's Economic Package
Mickey D. Levy

Economic Outlook
Mickey D. Levy

Some Observations on Monetary Base
Growth During Recoveries
Charles I. Plosser.

The Competitive Position of the United States
in the International Economy
William Poole

U.S. Foreign Exchange Market Intervention in 1992
Anna J. Schwartz

March 7-£,1993

SHADOW OPEN MARKET COMMITTEE

The Shadow Open Market Committee met on Sunday, March 7, 1993 from 2:00 PM to 6:00 PM
in Washington, D.C.

Members of the SOMC:

Professor Allan H. Meltzer, Graduate School of Industrial Administration, Carnegie Mellon
University, Pittsburgh, Pennsylvania 15213 (412-268-2283 phone, 412-268-7057 fax); and Visiting
Scholar, American Enterprise Institute, Washington, DC (202-862-7150 phone)
Professor Jagdish Bhagwati, Department of Economics, Columbia University, New York, New
York 10027 (212-854-6297 phone, 212-854-8059 fax)
Mr. H. Erich Heinemann, Chief Economist, Ladenburg, Thalmann & Co., Inc., 540 Madison
Avenue-8th Floor, New York, New York 10022 (212-940-0250 phone, 212-751-3788 fax)
Dr. W. Lee Hoskins, President and CEO, Huntington National Bank, 41 S. High Street, Columbus,
Ohio 43287 (614-463-4239 phone, 614-463-5485 fax)
Dr. Mickey D. Levy, Chief Economist, CRT Government Securities, Ltd., 7 Hanover Square, New
York, New York 10004 (212-858-5545 phone, 212-858-5741 fax)
Professor Charles L Plosser, William E. Simon Graduate School of Business Administration and
Department of Economics, University of Rochester, Rochester, New York 14627 (716-275-3754
phone, 716-461-3309 fax)
Professor William Poole, Department of Economics, Brown University, Providence, Rhode Island
02912 (401-863-2697 phone, 401-863-1970 fax)
Professor Robert H. Rasche, Department of Economics, Michigan State University, East Lansing,
Michigan 48823 (517-355-7755 phone, 517-336-1068 fax)
Dr. Anna J. Schwartz, National Bureau of Economic Research, 269 Mercer Street - 8th Floor,
New York, New York 10003, (212-995-3451 phone, 212-995-4055 fax)

Shadow Open Market Committee

SOMC POLICY STATEMENT SUMMARY

Washington, March 8—The Shadow Open Market Committee expressed disappointment at
the administration's fiscal program and criticized Congressional proposals to change the structure
of the Federal Reserve. It called for the rapid approval of a GATT agreement.
The Committee called the $30 billion short-term fiscal stimulus "unnecessary." The economy
is growing at a healthy rate and is experiencing the best productivity growth in 20 years.
The long-term package is misguided, the Committee said. "Despite the rhetoric of growth,
consumption is favored over investment" Long-term productivity growth and standards of living
will not be increased.
Fiscal policy is most effective if used to increase long-term growth. To increase growth, 1)
cancel the tax increase on corporate income, 2) tax spending instead of income saving, 3) reduce
spending on entitlements and 4) reduce regulation. The administration's heavy reliance on tax
increases will slow the economy. The current momentum is strong, however, the Committee said.
The Shadow Open Market Committee (SOMC) meets in March and September. The March
1993 meeting is the 40th meeting.
The SOMC warns that the present low rate of inflation will not remain if the inflationists in
Congress succeed in their efforts to reduce the independence of the Federal Reserve. Pressures
from Congress make the Federal Reserve less willing to act promptly against a return of inflation.
The Federal Reserve increases the risk of higher inflation by basing its actions on changes in
the unemployment rate. This measure is a lagging indicator of the momentum in the economy.
The Federal Reserve should tighten policy slightly by returned growth of the monetary base
to 8 percent in 1993. This would lock in the past gains against inflation and contribute to a sustained
expansion, the SOMC said.
Immediate approval of the GATT agreement will sustain expansion of trade. The administration currently has no coherent trade policy. It leans in a protectionist direction that encourages
interest groups to demand special favors. This will harm the U.S. and world economy if it continues.

March 7-8,1993

Shadow Open Market Committee

SHADOW OPEN MARKET COMMITTEE
Policy Statement
March 8,1993

Once again output is rising and the economy is on a path toward higher growth. Inflation is
low. Unfortunately, the administration has chosen a program that will not increase growth of output
and productivity. Taxes will rise, and spending will continue to rise. Additional tax increases will
be required by the health reform program. Expectations will be depressed by mandated increases
in production costs.
Voters who wanted a change should be disappointed. The new policies of the administration
return to the past. Tax rates willrise,spending for redistribution will increase. Despite the rhetoric
of growth, consumption is favored over investment, and Members of Congress have tried to neutralize the Federal Reserve as an effective force against a rise in inflation.
The administration speaks with many voices on international trade. U.S. leadership toward
a freer more competitive trade policy is threatened. The U.S. should move now to accept the GATT
agreement as it stands and complete the current negotiations prompdy.
THE CLINTON PLAN
The new administration describes its program as combining short-term stimulus to
employment with long-term growth and deficit reduction. President Clinton often says that no one
before has tried to reduce the budget deficit while expanding the economy.
His statement is false. On many previous occasions, growth rose while the budget deficit
fell. Growth raises incomes and revenues. If government spending is controlled, the deficit
inevitably shrinks. Productivity and living standards canrisewhile the deficit shrinks if government
encourages investment and restricts government and private spending for consumption.
President Clinton's plan does not take this course. Government spending for consumption
and redistribution would increase. The projected Health and Human Services budgetrisesby $200
billion in the four years ending in 1997. Total government spending is not reduced, as so often

March 7-8,1993

claimed. The President's plan increases total spending 3.2 percent a year or $202 billion in four
years, after a $93 billion increase in fiscal 1993. Taxes fall most heavily on corporate and private
saving and on private capital.
Despite $ 126 billion planned reduction in defense spending in the next four years by Presidents
Bush and Clinton and $280 billion of tax increases, the structural budget deficit falls only $140
billion in four years. The structural deficit remains above $200 billion in 1997. The share of output
spent by governmentis a better measure of the role of government. This measure falls insignificantly
under the President's program.
The program will not achieve its goals. Much of the deficit reduction is confined to later
years and depends on spending cuts and program terminations that Congress has rejected many
times. Tax increases will slow the economy, so tax receipts will be lower than projected. Already
the market for tax exempt bonds is booming. And the Clinton plan brings back tax incentives
—soon to be called loopholes—for investment in low income housing and certain types of
mortgages.
Experience in many countries shows that deficits have grown despite large tax increases.
Chart 1 shows that deficits typically have increased when taxes (government receipts) increased.
There is no systematic relation between the magnitude of the tax increase and the magnitude of the
change in the government deficit
The focus offiscalpolicy should be on resource use, not deficits. Fiscal policy affects resource
use by shifting resources between the public and private sectors and between consumption and
investment spending. The Clinton program talks about the desirability of more investment, but
does not shift resources toward investment The administration counts as investment the following
additions to spending: $9 billion for food stamps, $9 1/2 billion for AIDS and women's health, $2
1/2 billion for low-income housing, $6 billion for "national service," $2 billion for temporary,
summer jobs, $3 billion for community development, and $20 billion to raise the income of the
working poor.
Some of these expenditures may be useful. Some will be wasteful. None of the $50 billion
mentioned above will contribute much to the increase in knowledge, training, and physical capital
that is properly called investment
Short-term stimulus is unnecessary. The short-term program to create "jobs," like the
investment program, includes spending that is unrelated to its objective. Extending unemployment
compensation costs $5.6 billion but does not create employment and does not improve skills. Neither

Shadow Open Market Committee

does additional spending for AIDS, modernization of tax collection, or inoculation against measles.
Temporary investment tax credits change the timing of investment but do not permanently increase
investment, productivity and living standards. Temporary changes of this kind increase variability
and uncertainty.
The administration claims it will create 500,000 new jobs. Its numbers show that if the
proposal was not adopted, the unemployment rate would fall to 6.6 percent in 1994 and 5.8 percent
in 1997. The claim that under its program, the unemployment rate would be 6.4 percent in 1994
and 5.7 percent in 1997, achieves a decline of only one or two tenths of a percent. The differences
are about 260,000 and 130,000 jobs in an economy that created 1.6 million new jobs in 1992
according to the household survey.
The economy grew 4 percent in the second half of 1992, and the momentum continues.
Productivity growth in 1992,3 percent from 4th quarter 1991 to 4th quarter 1992, was the highest
in twenty years. Despite the cutbacks in defense spending, most of the unemployed find new jobs
within a few months. Unemployment lasting six months or more has been lower as a percentage
of total unemployment than in any major country.
We urge the Congress and the administration to recognize thatfiscalpolicy is most effective
if used to meet long-term objectives. They should 1) discard the short-term stimulus package, 2)
cancel the tax increases on corporate income, 3) substitute a tax on consumed income (spending)
for the current income tax, 4) reduce spending on entitlements and 5) reduce regulation. We believe
that this proposed package would do more than the administration's program to increase productivity
and standards of living and create better jobs at higher incomes. This program would shift spending
from public and private consumption toward productive investment
TRADE POLICY
The administration should accept the current draft of the Uruguay Round of the GATT
negotiations. Substantial reductions in trade barriers have been achieved and significant expansion
of trade will result. Issues which remain unresolved should be addressed in a subsequent round of
negotiations.

March 7-8,1993

MONETARY POLICY AND INFLATION
Inflation has at least been brought near the zone of price stability. Long-term interest rates
are back to levels not seen during expansions since the 1960s. If the Federal Reserve continues to
encourage non-inflationary growth, the economy can achieve sustained expansion with high
employment. This will encourage long-term investment and productivity.
In the last three decades many financial market commentators have become so accustomed
to alternating periods of stop and go monetary policy that they believe that economic expansion
necessarily brings inflation. This view is false. We can have expansion without inflation if monetary
policy is set now to achieve medium-term price stability. A policy of this kind encourages long-term
growth and productivity increasing investment Unfortunately, we seem likely to repeat the fiscal
and monetary mistakes of the 1970s.
Chart 2 shows the recent swings in Federal Reserve actions—measured by the annual growth
rate of the domestic monetary base—and the growth of spending, nominal GDP. The domestic
base excludes currency held abroad.
In the years since 1985, changes in the growth of spending have followed changes in the
growth of the domestic base with a six quarter lag. Slower growth of the domestic base in 1988-90
contributed to slower growth of GDP in 1990-91. During the recession, growth of the domestic
base increased, followed by growth of spending.
Recent growth of the domestic base is consistent with growth of nominal GDP of about 7
percent. In fourth quarter 1992, nominal GDP rose 7.1 percent If monetary expansion continues
at recent rates, inflation is likely to rise toward 4 percent by 1994.
We believe growth of the domestic base should be reduced in 1993. To achieve this reduction,
growth of the reported base (as published including foreign holdings of currency) should be reduced
to about an 8 percent annual rate. The Federal Reserve should measure the domestic monetary base
and release this information to the public.
We have little confidence that the Federal Reserve will adopt the policy we recommend for
two reasons. First, the Federal Reserve now bases its actions on changes in the real economy,
particularly changes in the unemployment rate. This procedure ensures that the Federal Reserve
will fail to act in a timely way to prevent a rise in inflation. Second, the Congress encourages delay.
The inflationists in Congress, led by Senator Sarbanes, have introduced legislation to make the
Federal Reserve less independent and, therefore, less willing to control inflation prompdy.

Shadow Open Market Committee

The proposed legislation confuses independence and accountability. Congress and the
administration should require greater accountability. They should assign to the Federal Reserve
responsibility for maintaining price stability and require the resignation of the members of the
Federal Open Market Committee if this objective is not met.
Since 1981, we have urged increased accountability for an independent Federal Reserve.
Under our proposal, the Federal Reserve would announce an annual target for money growth. The
Federal Reserve would remain independent but would have to choose a single target and specify
its rate of growth. If the rate of growth was not achieved, the FOMC members would offer their
resignations and an explanation of the reasons for missing the target. The President could accept
the explanation or the resignation. A modified version of this proposal, substituting a 2 percent
inflation in place of money growth, has been adopted in New Zealand where it has worked successfully.
We congratulate the Federal Reserve and the Treasury on ending the warehousing of foreign
currency. The next step should be elimination of authority to "warehouse." Nevertheless, intervention in foreign currency market continues and, with the appreciation of the dollar, exposes the
public to the risk of substantial currency losses on the authorities' portfolios.
Should taxpayers pay higher taxes so that monetary authorities can speculate on currency
values in the name of policy coordination?

March 7-8,1993

CHART 1

Changes in General Government Receipts and Balance
OECD Countries, 1972 -1990
Percentages of GDP

5 r
I

JD
75
o
c
co
c

Japan

= Q.CQ
3> - • CD

Ireland
U.K.

*-*
c
a>

U.S.
•

E -5
c

Netherlands
#
Germany

Norway

#
Australia

#
Canada

I*.

Italy

France

Austria

CO
c

Belgium

Sweden •

Denmark

O
O)

#
Portugal

a
22

5 -10

CD
C
0)
G)

CO
CD

#
Finland
Greece

-15 h

C
CO

5
10
Change in general government receipts

Source: OECD Economic Outlook 1992, Tables R14, R16

Chart 2
GROWTH RATE OF SPENDING AND DOMESTIC MONETARY BASE
(GDP)

GROWTH
RATE

(S
o\

1985
1986

1988
D

Spending

1990

1992

+ Domestic Base six quarters earlier

March 74,1993

Shadow Open Market Committee

THE URUGUAY ROUND AND FREE TRADE AREAS
Jagdish BHAGWATI
Columbia University

President Clinton faces two immediate questions of high policy in regard to trade questions:
i)

the position to take on the Uruguay Round's completion; and

ii)

on the broad question of Free Trade Areas such as NAFTA, where the ClintonGore team has already endorsed NAFTA itself subject to further negotiated
understandings on environment and labor issues and where the Congress can be
reasonably expected to sign on, whether to:
a)

terminate the process of getting more FTAs signed; or

carry on the process with more FTAs being signed only with South
America, as was the U. S. policy under the Enterprise for Americas initiative
until President Bush's Detroit speech in the campaign; or

proceed with FTAs on a worldwide basis, as promised in the Bush speech,
extending them immediately to Eastern European countries, countries of
East Asia and indeed everywhere.

THE URUGUAY ROUND
Uruguay Round: Reasons Favoring Conclusion
There are several reasons to conclude this Round, as substantially negotiated to date:
Gains from Success:
1.

Economic Benefits:
i)

There are the much-advertised gains from expanded trade. The figures
bandied about is $200 billion worth of added trade, with associated gains
from this trade being a fraction of this number, of course. The numbers
are somewhat ballooned up and such numbers are in any case not as hard
as they appear to the untrained eye. But the direction of change is clear:
there will certainly be a significant expansion of trade and associated gains.

March 7-8,1993

ii)

The Round's success also translates in political language into jobs. More
important, it would spur added investment, just as Europe 1992 stimulated
Europe out of its pessimism into more investment For both reasons, the
Round's early success is critical to our and other OECD countries' efforts
to escape more assuredly from the global recession.

Political Benefits:
i)

In political terms, each country looks at the political costs of adjustment
to imports, thus attaching greater value to concessions gained than to
concessions given. (Economists value exports and imports equally, on the
other hand, as long as they are a product of appropriate policy design which,
President Clinton should note, excludes managed or "results-oriented11
trade.) By this political criterion, we are almost in a win-win position on
the Round: we have gained a great number of concessions (in intellectual
property, in services, and in the grain agreement with the EC: all areas
where we have major export gains) and made big import concessions
mainly in textiles (by agreeing to a 10-year phaseout of the Multi-fibre
Agreement, a blot on the trade scene, but then too on a schedule which is
end-loaded, sparing us adjustment costs in the early years). For us to turn
away from such an unbalanced trade bargain in ourfavor, simply because
each lobby wants more and more, would be foolish.

Triumph of Rule of Law:

The Round also strengthens the Dispute Settlement mechanism and thus
helps us, and others, enforce their trading rights without disruptive threats
and skirmishes, replacing the law of the jungle with the rule of law. Thus,
in the recent oilseeds dispute, the fact that two impartial GATT Panels had
found in our favor meant that Mrs. Hills could isolate France effectively
within the EC with her threat (which carried far more moral force than if
we had unilaterally decided that the EC was in violation of our trading
rights). Again, under the reform included in the Dunkel Draft of the Round

Shadow Open Market Committee

agreement, the EC could not have vetoed at the Council the verdict of the
second Panel which found in our favor. With these reforms, everyone
would have to agree to overturn a Panel finding for it not be binding.
Costs of Failure:
i)

The costs of failure include, of course, the foregone gains from success,

ii)

But there would also be sins of commission. Two may be highlighted.
a)

If the Round fails, even the MacSharry reforms of the EC s CAP policy in
agriculture, and the resulting liberalization of trade, will slide back. We
will not be able to sit back but will be retaliating, as President Bush began
to do during the campaign, with our own export subsidies. The subsidy
war will be on third markets' turf in many cases, angering our friends in
Australia (recall the strong farmer demonstrations against President Bush),
Argentinaand others. It will also bust our budget further.

With the failure inevitably attributed to the "intransigency" of the EC and
others abroad, and changed therefore in the political lexicon to their "unfair
trade" and "closed markets," one can bet that both the Congress and the
administration will find it ever harder to fight off protectionist demands
and to silence those who wish to indulge in unilateral aggression such as
through Super 301 and 301 actions. Ms. Laura Tyson is already a proponent
of such universally-condemned measures; few would be able to dissent
effectively from her if the Round is killed and the GATT wounded.

Finishing the Uruguay Round
Unfortunately, the Clinton administration failed to close the Round before March 2nd,
requiring, therefore, a renewal of fast track authority. This opens the Round to renewed pressures
from special interests which want even more concessions and which, therefore, will work through
Congress to attach riders to the renewal of the fast-track authority.
Since the better option of standing up to special interests and to close the Round was not
taken, whether willfully or because the Clinton Administration could not get its act together, one
must judge this as an important failure of the new administration in trade policy. While the

March 7-8,1993

administration's likely request now for renewal of the fast-track authority will probably be sold as
a sign of the administration's commitment to multilateralism, this claim would hardly be persuasive.
For, having failed tofinishthe Round before a renewal of the fast-track authority became inevitable,
we now face only two options: either ask to renew the fast-track authority or not ask for it. Surely
the latter would be a crazy option to prefer.
It is probable that the Administration itself will want to satisfy the special interests instead
of standing up to them: all actions so far, such as the threat to leave the procurement code at the
GATT, speak to the Administration's desire to accommodate demands from domestic industrial
lobbies. So do the Clinton campaign's promise, the President's chief economic adviser's writings,
and the demands in Congress, for revival of the now lapsed Super 301 legislation that strengthens
our capacity and willingness to indulge in aggressive unilateralism in trade.
The danger is that, as the new administration accommodates more such demands and policies,
hoping to extract more concessions from other nations even as we already have a heavily-unbalanced
bargain in our favor, the delicate balance of interests in the "Dunkel draft" (now before us in Geneva
for signing to conclude the Round) will unravel. The "fine-tuning" that the Clinton administration
presumably wants, in walking to the edge, is dangerous and misjudges badly the increasing sense
abroad that the U.S. trade policy is getting captured by special interests and turning myopic.
Excessive demands will precipitate, not more concessions, but disintegration of the Round.
Lobbies and Further Negotiations
To close the deal, the Clinton administration will then have to confront the lobbies and tell
them; enough is enough.
To do this more effectively, it is important that the lobbies understand that the closing of this
Round is not the end of negotiations, that "unfinished business" will continue to be negotiated. The
modalities by which this can be done are essentially twofold:
Option 1: Declare a new Round as you close this one. Specify the main issues you will want
included in the new Round. The main items of interest will include two areas for sure: competition
policy and the need to reconcile the needs of the two great issues of our time: trade and the environment. The President will need to assure the environmentalists, who discovered the GATT only
recently, that their misgivings will need extensive negotiations among the trading nations; that they
can indeed be addressed satisfactorily in the next Round; and that holding up the current one is
simply a spoiler's option.

Shadow Open Market Committee

Option 2: Instead of a new Round, negotiate each area by itself, having open-ended, continuous negotiations much like Mao Tse-tung's "permanent revolution!"
The former option seems preferable, since tradeoffs across issues typically play an important
role in advancing the removal of trade barriers. Such tradeoffs are evident in the Uruguay Round
itself: EC's agricultural concessions are helping the acceptance by developing countries of our
demands in services and intellectual property protection, for example.
BEYOND THE NAFTA ON FTAs VIS-A-VIS MULTILATERALISM
Finally, the three options listed at the outset must be confronted by President Clinton. Of
these, Option 1 makes the most sense for reasons sketched below.
In Option 1, we terminate FTAs at Mexico. This means that we concentrate on multilateralism
as above, putting our weight wholly and exclusively behind it as we did until 1982.
The main argument for returning to our nondiscriminatory ways in trade and stopping at
Mexico with NAFTA, is that we began the U.S.-Canada Free Trade Agreement really because we
could not get the EC to agree to starting a new Round in 1982. By threatening "exit," we served
notice that only a new Round which would bring the GATT up-to-date with new issues and disciplines would make us return to "loyalty." Well, we did manage to jump-start the Uruguay Round
and now, with the Round closing, we have jump-started the multilateral process too. Why then
proceed with discriminatory trade arrangements any further?
The FTAs approach confined to the Americas, in Option 2, has the further demerit of creating
an acute sense that we are fragmenting the world economy into another trading bloc, thereby
encouraging the creation of a "defensive" Asian bloc centered on Japan, where there is currently
none but surely will be, and thus actually fragmenting the world economy. This is certainly a
deleterious outcome, undermining the GATT process which is now working well. (The GATTis-dead or GATT-should-be-killed school of economics fails to understand that the FTA approach
is no more fast and efficient in reducing barriers than the GATT process. After 35 years since the
1957 Treaty of Rome, the EC is still to dismantle all barriers; the NAFTA involving only three
countries has taken a decade to reach its current accord, whereas the Uruguay Round involving 108
countries and a whole slew of issues has only just begun to enter its seventh year and will soon
settle! But facts and logic yield to gung-ho regionalism at times.

March 7-8,1993

The problem about the Enterprise for Americas Initiative is that it was mixed up with the
FTAs approach by the Treasury and then the State Department under Secretary Baker. Given the
hazard it poses to the progress of the multilateral nondiscriminatory trading regime, now well under
way, it is time to djelink that initiative from FTA offers and to return to the several other instruments
of aid and solidarity with these new democracies, just as President Kennedy's Alliance for Progress
offered in his time (when preferential trading arrangements were most certainly not part of the
Kennedy initiative).
If President Clinton accepts this argument, then we must stop FTAs at Mexico, deny one to
Chile on grounds of high (trade) policy, reaffirm other aspects of an initiative for the Americas that
do not undermine the multilateral system and its evolution through bloc-formation, and also call
off the search for new FTA partners elsewhere, as in Option 3.
Even Option 3, which opens up our FTAs on a worldwide basis to Taiwan, Korea, Eastern
Europe, etc, will inevitably (in practice) turn the world into trading blocs. Countries such as India,
Pakistan, Egypt, Kenya, Ghana, etc. many of which are turning to outward orientation see themselves
as effectively being marginalized by our FTAs policy, since they have no real option to join either
the EC or the Japan-centered bloc or our NAFTA, no matter what openendedness we announce.
Would the Congress really to able to deliver on an FTA with India, for instance?
Talk is cheap; action will be difficult and improbable. The outcome will in reality be all kinds
of world-economy-fragmenting, preferential alliances. Ironically, this would happen just when in
fact our leadership at the GATT, and for the GATT, offers the promise of bringing to fruition the
efforts of Cordell Hull, Douglas Dillon, President Kennedy and countless others who correctly
worked for an open, multilateral trading system.
President Clinton must make his choices soon, before the die is cast with FTAs with Chile,
already at the edge, and with Taiwan, eager to explore with us the same possibility.

Shadow Open Market Committee

FEDERAL RESERVE INDEPENDENCE AND ACCOUNTABILITY
W.LeeHOSKINS
Huntington National Bank

Once again, the Federal Reserve is under attack from lawmakers who propose measures
designed to increase the accountability of monetary policymakers while preserving the independence of the institution. Legislation that is currently the subject of debate on Capitol Hill would
either remove the voting power of District Reserve Bank presidents or require that they be appointed
by the President of the United States and confirmed by the Senate. These efforts (well-intentioned
or not) to improve the process of making monetary policy cannot possibly improve the substance
of policy, because they do not address the central shortcoming of the present framework: the absence
of a single, clear, measurable, and attainable objective for monetary policy. Instead, the political
leadership focuses on a mix of objectives that no central bank can deliver. While providing a
convenient scapegoat for politicians and protective cover for central bankers, the existence of
multiple objectives that vary in importance over time precludes the intentional and lasting
achievement of any objective. In particular, price stability and the benefits that accompany it are
lost in the process. Price stability should be the dominant objective of monetary policy because it
promotes an environment conducive to achieving the highest standard of living that our endowment
of real resources and human capital will permit. Federal Reserve independence and accountability
are essential to achieving this objective.
Most politicians confuse the notions of independence and accountability, and by doing so
blur the debate over central bank reform. As typically used, the phrase "independent but
accountable" is meant to imply that monetary policymakers should be insulated from political
pressures, yet not allowed free reign. In the most general sense, however, independence and
accountability cannot coexist because one cannot be simultaneously "autonomous" and "answerable." Experience over time and around the world illustrates the importance for central banks of
insulation from political pressures. Yet at the same time, there remains the dilemma that no public
policymaker—however selected—should enjoy complete autonomy.
The answer is to give central bankers freedom of action (independence) in the pursuit of a
single, clear, measurable, and attainable objective, while making them answerable (accountable)
for the results of their actions. Independence in pursuing a stated objective—that is, the freedom
of action—insulates the institution from political pressures for policies that could impede

March 7-8,1993

achievement of the objective. In this context, independence avoids the pitfalls of policy rules that,
however flexible and well grounded initially, could become outmoded or under some unforeseen
circumstances become destabilizing forces. In contrast, independent policymakers have the freedom
to adapt, as markets evolve and our understanding of the economy grows, and implement the most
effective methods of achieving the stated objective.
But freedom to act without undue interference is not enough. The Federal Reserve has been
one of the most autonomous central banks in the world during the postwar period, yet its performance
on occasion has been disastrous—witness the one-third contraction in money in the early 1930s
and the fourfold increase in the price level since 1950. In addition to having independence of action,
central bankers must be held accountable for the results of their actions. Ideally, central bank
policymakers themselves should be held accountable for achieving the policy objective. The
Reserve Bank of New Zealand is a good example. The responsibility for achieving an inflation
rate of between zero and two percent rests solely with the Governor, who is appointed to a five-year
term by the Minister of Finance. The only other explicit charge is to ensure the soundness of the
financial system. If the target is not met, the Governor may be removed by the Minister. Concerns
over the personalities or politics of central bank officials and the dangers of discretion in policy
formulation melt away under a system that combines accountability for specific results with the
independence necessary to achieve them. In such a world, the process used to select individual
policymakers is important only with respect to its success in attracting and retaining the most skilled
individuals.
It is unlikely that recent reform initiatives would improve the current process in the United
States. The Federal Reserve Accountability Act of 1993, H.R. 28, introduced in the House on
January 5,1993 would require that the presidents of the Reserve Banks be appointed by the President
of the United States and confirmed by the Senate. The Act further instructs the President to include
among those candidates representatives of agriculture, small business, labor, consumer and community organizations, women, and minorities. In addition, the selection process for the directors
of Reserve Banks would be altered. Three Class A Directors would be elected by commercial
banks, as under current practice, with the added stipulation that only domestically chartered and
owned banks could vote. Six Class B Directors would be appointed by the Board of Governors,
up from three currently, again with directions to include minorities and representatives of specific
groups. A stated aim is to make the Reserve Bank Presidents the equals of Governors; however,
the twelve Presidents would apparently continue to share five votes at FOMC meetings on a rotating
basis (although the bill is not clear on this), whereas the seven Governors would retain permanent

Shadow Open Market Committee

votingrights.Comparable bills introduced in the House and the Senate on January 26 would abolish
the FOMC, make the Board of Governors solely responsible for the conduct of monetary policy,
and establish a Federal Open Market Advisory Council, through which the twelve regional bank
presidents could advise the Board of Governors. All of the bills would mandate greater disclosure
of policy deliberations and authorize more comprehensive audits of Federal Reserve activities.
None of the legislation would explicitly restrict the independence of policymakers to act, but
in the absence of the overriding objective of fostering a high standard of living by maintaining
price-level stability, the injection of politics into the selection process would risk compromising
policy outcomes. If less emphasis was placed on the skills and experience necessary to formulate
and implement polices and stabilize the price level by the President or Congress than by the boards
of directors of District Reserve Banks or if the President or Congress actually sought individuals
predisposed to pursue objectives other than price-level stability, the substance of policy would
suffer. There is every reason to believe this would occur. The appropriate response is to establish
therightobjective and adopt measures designed to ensure that it is achieved. In contrast, changing
the process of selecting policymakers can be counterproductive when they have the option, or even
the incentive, to choose the wrong objective. This is especially the case when legislators select
individuals precisely because they will make that choice
Congress should pass legislation to direct the central bank to promote the maximum attainable
level of employment and output by achieving and sustaining a stable price level. The Federal
Reserve should have complete freedom to select procedures and intermediate targets and design
and execute strategies without political interference. At the same time, it must constantly be held
accountable in a meaningful way for the results of its actions—for producing a stable price level
over time. The appropriate committees of Congress or the Executive Branch must have the authority
to, and be specifically directed to, remove and replace monetary policymakers if and when the actual
price level deviates from stability over a pre-specified time by a pre-specified amount.
Such legislation is unlikely from this Congress. In the meantime, Federal Reserve policymakers should not be distracted from resolutely pursuing price stability by a Congress focused on
"fine tuning" the economy with discredited economic theory and practice.

March 7-8,1993

Shadow Open Market Committee

PRESIDENT CLINTON'S ECONOMIC PACKAGE
Mickey D. LEVY
CRT Government Securities, Ltd.

The stated purposes of President Clinton's fiscal policy proposal are to provide short-run
fiscal stimulus to "guarantee" the durability of the economic recovery, and cut the deficit while
increasing outlays and subsidies for public and private investment and income maintenance.
Although well intended, the package has more weaknesses than strengths. The short-run fiscal
package is inappropriate and wasteful, and is inconsistent with the program's long-run objectives.
The deficit-cutting package includes many initiatives that save money and increase efficiency (many
have been proposed but rejected before). President Clinton certainly deserves credit for treading
where recent politicians have failed. However, the major thrust of the package is disappointing in
several key regards: 1) excluding the defense budget, its proposed cuts in spending are insufficient
and heavily back-loaded into the later years, 2) it barely cuts into nonmeans-tested entitlement
programs and proposes significant new spending of income maintenance, 3) the combined spending
and tax proposals fail to materially reallocate resources from consumption-oriented transfer payments to investment-oriented activities, and 4) its key investment tax incentives are temporary,
and the overall tax scheme lacks a sense of stability or predictability necessary for business planning
and healthy economic growth.
The basic framework of this package is likely to be enacted. If so, it will cut the deficit from
current law projections. However, it is unlikely to generate new permanent jobs, or add materially
to productive capacity or long-run economic growth. In light of the grand window of opportunity
the political and economic environment now provides, in several years President Clinton will likely
regret his initial lack of aggressiveness in cutting spending.
SHORT-TERM FISCAL STIMULUS?!
The recession ended nearly two years ago, and the rate of real GDP growth has exceeded 4
percent since mid-1992, so the short-term fiscal stimulus initiative is untimely, costly, and inconsistent with the Administration's deficit cutting objectives. It sets a bad tone for fiscal policy by
estabttshing the wrong set of expectations about the role of fiscal policy should play in the
economy. The package will cost approximately $30 billion. The bulk of the $16 billion proposed

March 7-8,1993

stimulus spending would fund a temporary summer jobs program and a summer Head Start program,
extension of unemployment compensation benefits ($5.6 billion), "fast spending" public infrastructure programs and a one-time supplemental appropriation ($2.5 billion) for Community
Development Block Grants. All of these initiatives are designed to quickly create temporary jobs
or provide income maintenance. They will not create permanent jobs, and the priority of funding
projects capable of creating temporary jobs the fastest biases the chances of allocating resources to
their most efficient uses.
The proposed stimulus package includes approximately $12 billion in tax investment
incentives. The marginal investment tax credit will not permanently lift businessfixedinvestment;
because it is temporary, it will only change the timing of investment and distort its mix by
encouraging investment in certain short-lived equipment. The temporary nature of the subsidy
virtually guarantees that the tax system will continue to be unstable and unpredictable,
essential elements for business planning, rising investment, and healthy economic growth.
Clearly the political impetus for this short-term stimulus package is that while real GDP is
growing rapidly, the growth in economic output is being generated primarily by productivity gains,
while employment is growing only slowly. Nevertheless, it is misguided. Job growth is picking
up, and the productivity gains resulting from substantial private sector restructuring creates the basis
for permanent employment growth in higher value-added jobs. Budget resources should be allocated
to high return activities that raise productive capacity and permanent job growth, not temporary
quick fixes based on outdated campaign promises. This is particularly true now that the recovery
is durable and real growth is far above its long-run average.
THE DEFICIT CUTTING PROGRAM
The Administration's fiscal package has some positive characteristics as well as some
well-advertised negative ones. Its budget proposal and measured savings are based on the economic
assumptions of the Congressional Budget Office, which reducesoinnecessary and counterproductive
debate about economic projections at the expense of budget and fiscal policy. The CBO's
assumptions are "realistic" and should not be the source of gross miscalculations that have plagued
recent budget proposals and legislation. In fact, if anything, they may be underestimating economic
growth and longer-term productivity gains (its baseline projection assumes real GDP will grow less
than 3 percent annually through 1995, tailing off to 2 percent in 1998).

Shadow Open Market Committee

Secondly, the deficit-cutting proposal is more meaningful than earlier attempts that established
artificial deficit targets like Gramm-Rudman-Hollings and its successors. Those laws failed because
their deficit targets were artificial, they invited efforts to circumvent their intent, and they were not
accompanied by tax and spending legislation necessary to achieve them. Despite its many weaknesses, the Clinton proposal is a clear repudiation of the deficit targeting approach and an admission
that lacking enforceability they only lowered credibility of the fiscal policymakers.
Thirdly, the budget package includes a long list of proposals that would both save budget
dollars and generate economic efficiencies. Even though their combined savings would be only a
small portion of the proposed deficit reductions, they represent improvements. For example,
proposals to reduce some of the government's agricultural price supports and subsidies are wise,
as is streamlining the USD A; even bolder initiatives are required. Improving the operating efficiency
of the Department of Veterans Affairs, as well as eliminating overlaps in federal educational aid
programs, similarly are steps in the right direction. Requiring states to share default costs in the
Student Loan Program would improve operations; even if the net savings to taxpayers fall short of
projections (because states incurring default-related fees may raise taxes), it would nevertheless
create the right management incentives. The effort to extract savings from general government
operations is obviously welcomed and should not have any material impact on efficiency. Many
of these and other savings initiatives have been proposed before and rejected by Congress, but
obviously they now have a better chance of enactment
Unfortunately, the major shortcomings of the proposal overshadow these positive initiatives.
Projections of deficits are reduced but are associated with an enlarged role of the government in
the economy, the rapidly growth nonmeans-tested entitlement programs are not materially reduced
in scope (although the forthcoming health care package possibly could change this assessment),
and many of the new spending initiatives are unlikely to achieve their long-run objectives. The tax
policy changes perpetuate economic distortions. The major problem remains that fiscal policy
generates a sizable allocation of national resources toward consumption-oriented activity at the
expense of saving and investment, which reduces productive capacity and lowers standards of living.
The way in which the Clinton Administration proposes to reduce deficits and the new spending
initiatives do little to address this long-term problem.
Following the short-term stimulus, which would raise the rate of spending growth and the
deficit in fiscal year 1993, the Administration proposes slowing outlay growth to approximately
3.7 percent annualized from 1993-1997, from 4.5 percent annualized growth under current law, and
raising the growth of tax revenues to approximately 6.9 percent annually from 5.5«percent under

March 7-8,1993

current law (These are estimates based on the Administration's budget document, A Vision ofChange
for America, which does not provide proposed aggregate spending and tax revenue levels, and the
CBO's The Economic and Budget Outlook: Fiscal Years 1991-1997, January 1993.). Thus, outlays
would continue to grow in real terms.
The Administration proposes raising the deficit to $332 billion in FY 1993 (5.4 percent of
GDP) and then lowering it to $206 billion in 1997 (2.7 percent of GDP), a cumulative five-year
(1993-1997) savings from current law of $312 billion. Broken down, the savings would be generated
by new revenue increases of $249 billion and $246 billion in spending cuts, offset by $117 billion
in new spending initiatives and $66 billion in tax cuts. This would lower budget outlays from 23.5
percent of GDP in 1993 to approximately 22.2 percent in 1997, and raise tax revenues from 18.6
percent to approximately 19.5 percent. The slowdown in actual spending would be less and the
acceleration in revenues actually would be more, since several of the key deficit cutting proposals
involve raising fees, selling government assets and raising certain taxes that are counted as "offsetting receipts" (negative spending).
More important than the debate about how much budget savings is generated by tax
hikes or spending cuts (and how the budget accounts for them) is how the proposal affects
the allocation of resources, and here the package is disturbing. It does little to arrest the long-term
trend of distorting the allocation of national resources toward consumption at the expense of saving
and investment It does not materially alter the large portion of outlays for nonmeans-tested
entitlements, and the new resources actually allocated to true investment are far less than the numbers
in the budget proposal imply. Thus, the proposed permanent tax hikes would continue to sap saving
and private investment, harming long-run economic growth.
Presently, 50 percent of total budget outlays are for mandatory entitlement programs, and
approximately 75 percent of those are not means-tested; the Administration proposes increasing
the total share of entitlements and not materially reducing the share of nonmeans-tested entitlements.
The highly visible tax hike on social security benefits would reduce net benefits by $21 billion
during 1994-1997; this constitutes a minor 1.5 percent reduction from current law and would still
provide that net social security outlays would rise at a 4.5 percent average annual rate, and increase
as a portion of total budget resources. The proposed cuts in health care are aimed primarily at
reducing federal subsidies to medical providers, and do not alter the thrust of government subsidies
that support the soaring demand for medical services. The forthcoming health care package must
address this issue to successfully contain costs, particularly if health insurance coverage is extended.

Shadow Operi Market Committee

The other retirement programs, primarily for military and civil service go untouched. They will
cost approximately $70 billion or 4.8 percent of total outlays in 1993, and under current law are
projected to grow 5.3 percent annually through 1997 and rise as a percent of total outlays.
It is also questionable whether all of the projected budget savings will be achieved. Concern
that most of them are backloaded into the later years is warranted, given past experience (over 40
percent of the proposed savings would occur in 1977). Consider the following general ways these
projected savings may erode: 1) legislative slippage, such as further job-creating initiatives, 2)
savings in one program offset by higher costs in another (for example, budget savings from reducing
military personnel partially offset by higher costs of military retirement, health care, and unemployment benefits or federal spending to keep them temporarily employed), 3) less net government
saving due to negative economic impacts (for example, higher revenues from the energy tax partially
offset by job losses in certain energy-intensive manufacturers), and 4) general overestimation of
savings, for example, in areas such as defense and government administrative streamlining. Whether
such rapid cuts in defense outlays are feasible is uncertain. Net interest outlays are projected to be
$35.5 billion lower than under current law ($24 billion due to lower deficits and $11.5 billion by
shortening U.S. Treasury debt securities). These potential sources of savings slippage may be offset
by stronger-than-projected economic growth.
In this regard, re-estimates of President Clinton's budget proposal by the Joint Tax Committee
and the Congressional Budget Office suggest that the Administration overstates the cumulative
savings of the legislated changes by approximately $60 billion during 1994-1998. Based on the
same economic assumptions, the JTC projects that the proposed tax increases would raise
approximately $30 billion less through FY1998 than the Treasury Department estimates, while the
CBO projects that the White House's proposed spending cuts would produce approximately $30
billion less than the Administration estimates. The CBO re-estimates also find that the Administration's baseline against which the savings are measured is too high.
There are two general concerns about the Administration's new "investment" spending
proposals, which total $160 billion during 1994-1997. A sizable portion of them are actually for
income maintenance or activities not directly related to investment Secondly, some of the true
investment initiatives would be geared more toward short-term job creation than raising long-term
production capacity. Included as investment initiatives are the earned income tax credit, which was
originally established explicitly as an income maintenance offset to higher payroll taxes, and remains
a direct income subsidy (cost, $19.6 billion over 1994-1997), additional new spending of $25.6
billion on Food Stamps and various health programs, WIC (the supplemental food program for

March 7-8,1993

women, infants, and children, $2.6 billion), the extension of unemployment insurance ($2.4 billion),
and the low income housing tax credit ($2.6 billion). These add to over $50 billion; the list goes
on.
Certainly, some of the new investment projects may yield high rates of return to society, but
the political goal of adding quickly to job growth rather than choosing public projects that offer the
highest economic returns raises the chances of misallocating public investment funds. This bias
begins with the short-term fiscal stimulus package, in which funds would be allocated to what the
Administration refers to as "ready to go" and "fast spending" public projects and a set of "A Summer
of Opportunity" initiatives that offer immediate albeit temporary jobs; it continues with permanent
programs such as the Dislocated Worker Assistance Act, which will provide $4.6 billion for workers
displaced by NAFTA, the defense conversion, and Trade Adjustment. Whether more spending on
public investment projects permanently adds to (or subtracts from) the nation's productive capacity
and job growth depends crucially on the government's ability to choose higher yielding projects
than would be chosen by market forces. Over-emphasis on immediate job creation may actually
be inconsistent with the Administration's long-term objectives. Studies have found that Head Start
provides high rates of return to society, and the Administration proposes significant additional funds
for that program ($9.3 billion during 1994-1997). However, previous government-sponsored job
training programs generally have provided very low rates of return, so high expectations about the
productivity enhancing abilities of the new youth apprenticeship and job training programs are
based on leaps of faith. While some of the Administration's investment programs may provide
high returns, the deck may be stacked against achieving significant aggregate and lasting benefits
from the entire investment program.
Tax Policy. This proposal would involve a significant increase in tax revenues in real terms
and as a share of national output, assessed primarily on high income taxpayers through higher
marginal rates on personal income and higher FICA taxes earmarked for Medicare, higher taxes on
social security benefits, new energy taxes that would fall on all households, and higher marginal
corporate taxes whose aggregate burden would be offset in 1993-1994 by the temporary marginal
ITC. New user fees would be the source of additional revenues. The tax proposals reintroduce
degrees of complexity that policymakers strived to eliminate in recent years, and the temporary
nature of some key provisions add instability and unpredictability to the tax system.
These tax increases would contribute to lower deficits. Although they would reduce economic
activity from what it would be otherwise beginning in 1994, the aggregate elasticity of labor supply
is not sufficiently large to reduce jobs and the tax base enough to offset the higher rates and legislated

Shadow Open Market Committee

base increases. The economy has sufficient underlying strength so that the tax increases may dampen
growth, but not generate recession. However, some of this reduction in government dissaving would
be offset by lower private saving and perhaps less foreign capital inflow. Most of the tax hikes
would be assessed on income, not consumption. The higher taxes on high income households would
reduce the rate of personal saving while the higher corporate taxes after the temporary MTTC expires
would reduce retained business earnings. Private investment would also be reduced, following a
short-run jump in response to the temporary marginal ITC. The higher permanent taxes on business
income would reduce expected rates of return on investment, which combined with reduced cash
flows, would lower investment This would reduce expected rates of return on U.S. dollar
denominated assets and dampen foreign capital inflows. Private investment decisions would also
be distorted by micro tax provisions that would alter expected after-tax rates of return among different types of capital and uncertainty about the future tax structure.
The bottom line is that while the budget proposal would reduce the deficit from current law
and arrest therisein the federal debt-to-GDP ratio, it may not accomplish its long-term objectives
of raising investment, productivity, and standards of living. The crucial issue is whether the
resources it would allocate to the government and government-sponsored activities would
generate a higher or lower economic rate of return for society than would be provided by
private uses from which they are absorbed. The changes of the mix of spending outlays and the
distortive costs of the higher proposed taxes suggest that the long-run economic impact may not
measure up to the Administration's expectations. If so, the lesson learned from this attempt at fiscal
responsibility is that the way in which deficits are cut are as important, if not more important, than
the magnitude by which they are trimmed.

March 7-8,1993

Table 1

BUDGET PROJECTIONS

1993

1994

1995

1996

1997

Annualized
Percent Change
1993 -1997

Receipts
Administration
CBO Baseline

1143
1143

.1251
1215

1323
1291

1408
1356

1471
1414

6.9
5.5

Outlays
Administration
CBO Baseline

1475
1453

1513
1507

1565
1575

1613
1643

1678
1733

3.7
4.5

332
310

262
291

242
284

205
287

207
319

Deficit
Administration
CBO Baseline
Administration
Current Baseline

319

301

296

297

346

As a Percent of GDP:
Receipts
Administration
CBO Baseline

18.6
18.5

19.2
18.7

19.3
18.8

19.6
18.7

19.5
18.7

Outlays
Administration
CBO Baseline

23.9
23.5

23.2
23.2

22.8
23.0

22.4
22.8

22.2
23.0

Deficit
Administration
CBO Baseline

5.4
5.0

4.0
4.5

3.5
4.1

2.9
4.0

2.7
4.2

Sources: Executive Office of the President, A Vision of Change for America.
February 17, 1993, and Congressional Budget Office, The Economic
and Budget Outlook: Fiscal Years 1994-1998. January 1993.

Shadow Open Market Committee

Table 2

ECONOMIC ASSUMPTIONS

1992
BASELINE ASSUMPTION

1993

1994

1995

1996

1997

1998

Percent Change, Fourth Quarter Over Fourth Quarter

Real GDP Growth
GDP Deflator Growth
Consumer Price Index Increase

2.7
2.4
3.1

2.8
2.5
2.8

3.0
2.4
2.7

2.8
2.3
2.7

2.6
2.2
2.7

2.2
2.2
2.7

1.8
2.2
2.7

Unemployment Rate (civilian)
91 -Day Treasury Bill Rate
10-Year Treasury Note Rate

7.4
3.5
7.0

7.1
3.2
6.7

6.6
3.7
6.6

6.2
4.3
6.6

6.0
4.7
6.5

5.8
4.8
6.5

5.7
4.9
6.4

1992

1993

1994

1995

1996

1997

1998

ADMINISTRATION POLICY
Real GDP Growth
GDP Deflator Growth
Consumer Price Index Increase

Percent Change, Fourth Quarter Over Fourth Quarter
2.9
2.4
3.1

3.1
2.8
3.0

3.3
2.9
3.1

2.7
3.0
3.3

2.5
3.0
3.3

2.5
3.0
3.4

5.7
4.9
6.4

5.5
5.0
6.4

Annual Average
Unemployment Rate (civilian)
91 -Day Treasury Bill Rate
10-Year Treasury Note Rate

7.4
3.5
7.0

6.9
3.7
6.7

6.4
4.3
6.6

6.1
4.7
6.5

5.9
4.8
6.5

Sources: Executive Office of the President, A Vision of Change for America.
February 17, 1993, and Congressional Budget Office
Note:
Baseline assumptions are from Congressional Budget Office, The Economic
and Budget Outlook: Fiscal Years 1994-1998. January 1993.

March 7-8, 1993

Table 3

PRESIDENT CLINTON'S
HIGHLIGHTS OF THE PLAN
(in billions of dollars)

1993 1994 1995 1996 1997 1998

1994- 1994 1997 1998
Total Total 1

301

296

297

346

390

1,241

1,630

-7
-4
-6
-3

-12
-10
-12
-6

-20
-15
-24
-6

-37
-20
-34
-7

-36
-23
-39
-8

-76
-50
-76
-21

-112
-73
-115
-29

*
*

-20

-40
-3

-65
-7

-98
-14

-106
-22

-223
-24

-329
-46

-20

-43

-73

112

128

247

325

Revenue Increases (-)

-3

-46

-51

-66

-83

-82

-246

-328

Gross Deficit Reduction

-2

-66

-93

-139 -195

-210

-493

-704

2
20
17

1
32
15

6
9
13

39
15

45
17

9
100
60

9
144
77

169

231

-39

-54

-92 -140

-148

-325

-473

332
5.4

262
4.0

242
3.5

205
2.9

241
3.1

916
3.3

1,157
3.2

Budget Deficit
Spending Changes:
Defense Discretionary
Nondefense Discretionary
Entitlements
Social Security
Subtotal
Debt Service
Total Spending Cuts (-)

Stimulus and Investment:
Stimulus Outlays
Investment Outlays
Tax Incentives
Total Stimulus & investment
Total Deficit Reduction
Resulting Deficit
Deficit as a percent of GDP

319

1
_*

*$500 million or less.

206
2.7

Shadow Open Market Committee

Table 4

Overview of the President's Proposals
(amounts in billions of dollars)
1994

1995

1996

1997

1,143

1,251

1,323

1,408

1,471

294
262
717
202

278
270
753
212

273
282
782
227

266
293
812
243

250
302
868
257

1,475

1,513

1,565

1,613

1,678

332

263

242

205

207

1993
estimate

Receipts
Outlays:
Defense
Nondefense discretionary
Mandatory
Net Interest
TOTAL
Deficit (consolidated)

Note: nondefense discretionary outlays include outlays for international affairs and domestic
programs; consolidated deficit combines on-budget transactions and off-budget transactions (Social
Security trust funds and the Postal Service).

March 7-8,1993

Table 5
CBO ESTIMATES OF THE ADMINISTRATION'S POLICY PROPOSALS
(By fiscal year, in billions of dollars)

1993

1994

1995

1996

1997

1998

301.6

286.7

284.4

290.0

321.7

359.7

Deficit Reductions
Discretionary spending
Mandatory spending
Debt service
Subtotal, outlays
Revenues6
Subtotal, reductions

0
0
0
0
_0
0

-3.4
-4.2
-1.6
-9.1
-45.8
-55.0

-7.7
-7.5
-5.2
-20.5
-52.4
-72.8

-28.4
-17.8
-11.1
-57.2
-68.1
-125.3

-56.2
-25.0
-20.4
-101.6
-84.8
-186.4

-63.4
-30.8
-32.2
-126.4
•86.0
-212.4

Deficit Increases
Discretionary spending
Mandatory spending
Debt service
Subtotal, outlays
Revenues6
Subtotal, increases

3.3
3.3
0.1
6.8
_0
6.8

13.0
3.8
1.4
18.2
18.2
36.3

22.6
5.9
3.7
32.1
13.3
45.4

31.8
7.0
6.8
45.5
11.7
57.2

39.4
7.1
10.6
57.1
12.6
69.6

44.5
7.3
15.1
66.9
14.3
81.2

Total Changes

6.8

-18.6

-27.4

-68.1

-116.7

-131.2

308.3

268.1

257.0

222.0

204.9

228.5

CBO Baseline Deficit*

President's Budget as
Estimated by CBO

SOURCES: Congressional Budget Office; Joint Committee on Taxation.
NOTE: The budget estimates reflect the proposals incorporated in the President's budgetary message of February 17. In early April the
President will present a formal budget containing detailed and revised budget proposals and updated budget estimates.
a.

Assumes compliance with the discretionary spending limits in the Budget Enforcement Act through 1995; discretionary outlays are
assumed to grow at the same pace as inflation after 199S.

Increases in revenues are shown with a negative sign because they reduce the deficit. Estimates of the Administration's revenue
proposals were prepared by the Joint Committee on Taxation.

Shadow Open Market Committee

Table 6
DIFFERENCES BETWEEN CBO AND ADMINISTRATION ESTIMATES OF THE
ADMINISTRATION'S PROPOSED BUDGET
(By fiscal year, in billions of dollars)
1993

1994

1995

1996

1997

1998

Administration's Estimate
of the Deficit

331.4

262.4

241.6

205.3

206.4

241.4

CBO Reestimates of the
Administration's Baseline
Revenues*
Deposit insurance
Other outlays
Subtotal

4.9
-13.9
-8.5
-17.4

b
-3.4

-5.7
12.9
-3.5
3.8

-16.0
-1.5
^5
-19.0

-27.7
-1.5

-5.2

-6.2
13.6
-1.6
5.8

CBO Reestimates of the
Administration's Proposals
Revenues*
Debt management
Medicare
Pay offsets
Debt service
Other outlays
Subtotal

-3.6
0.2
0
0
-0.2
-2.0
-5.6

8.8
1.6
0.6
0.6
-0.1
-0.7
10.9

4.3
2.7
0.9
1.0
0.4
0.2
9.5

5.7
3.3
0.4
1.4
0.9
1.3
12.9

6.6
3.9
1.3
1.7
1.6
2.5
17.5

5.7
4.9
1.8
2.0
13
-0.5
16.2

-23.1

5.7

15.4

16.7

-1.5

-12.9

308.3

268.1

257.0

222.0

204.9

228.5

Total Reestimates
President's Budget
as Estimated by CBO

^LS

-29.2

SOURCES: Congressional Budget Office. Joint Committee on Taxation, and Office of Management and Budget.
NOTE: The budget estimates reflect the proposals incorporated in the President's budgetary message of Febniary 17. In early April the
President will present a formal budget containing detailed and revised budget proposals and updated budget estimates.
a.

Increases in revenues are shown with a negative sign because they reduce the deficit. Estimates of the Administration's revenue
proposals were prepared by the Joint Committee on Taxation.

Less than $50 million.

March 7-8,1993

Shadow Open Market Committee

ECONOMIC OUTLOOK
Mickey D.LEVY
CRT Government Securities, Ltd.

The recession ended nearly two years ago, in April 1991. Following an anemic rebound, the
economy shifted gears in mid-1992, and real GDP growth exceeded 4 percent in the second half of
1992. Momentum has carried into 1993, and real GDP is projected to continue growing at a healthy
pace in 1993, approximately 3 percent-3.5 percent. Fueled by stimulative monetary policy, lower
interest rates, growing confidence in the economy and improving fundamentals, there is a higher
probability that growth will exceed that range than fall below it.
So far this expansion, most of the growth in economic output has been attributable to productivity gains, while employment growth has been modest A portion of these productivity gains
reflect structural adjustments in the private sector, not merely a cyclical jump that typically occurs
at the initial stages of recovery. Such productivity growth creates a strong base for sustained
economic expansion, including a pickup in job growth.
The Clinton Administration's economic proposal would provide a modest boost to economic
growth in 1993 through its temporary jobs programs and business investment incentives. Beginning
in 1994, enactment of the proposed sizable tax increases and the ongoing implementation of the
spending package would harm economic activity and alter its mix. However, given the strong
economic base, the new fiscal policy would dampen economic growth, but not generate recession.

A SLOW BUT HEALTHY RECOVERY
The recovery from recession began very slowly; real GDP grew 1.6 percent from second
quarter 1991 to second quarter 1992. Growth was inhibited by a number of structural adjustments,
including declining defense spending, excess inventory of office space and lower business
investment in structures, lower expectations of future housing prices, which constrained the rise in
housing activity, and general business restructuring of production processes, which limit employment and income growth. As a result, many recessionary-type conditions persisted, despite the
growth in output. During this period, export growth remained strong and business investment in

March 7-8,1993

information processing equipment staged a robust rebound, but these bright spots were overshadowed by the subpar performance in the more visible sectors of the economy and the lack of job
growth.
Positive cyclical factors began to overwhelm these adjustments and generated a marked pickup
in economic activity in mid-1992. The most important factor was the Federal Reserve's stimulative
monetary policy. In the last year, bank reserves have grown 14 percent, while the monetary base
and Ml have grown 12.5 percent, their fastest expansion since 1986. The federal funds rates is at
its lowest rate in 30 years and is zero in inflation-adjusted terms. While the entire term structure
of rates has receded, the yield curve remains very steep.
The only missing link in these indicators of monetary thrust has been the very slow growth
of M2 and the broader aggregates. M2 grew 2.1 percent from fourth quarter 1991 to fourth quarter
1992, below the Fed's target growth band of 2.5 percent-6.5 percent, and it has fallen since then.
However, all of this slowdown is attributable to an ongoing dramatic decline in small time deposits
(17 percent in the last year), two-thirds of which is from thrift institutions. The decline in CDs has
been a direct response of the steepness of the yield curve and the opportunity costs of holding M2
assets. A substantial amount of these financial assets have flowed into stock and bond funds and
M1. Banks, which are awash with liquidity and facing weak loan demand (commercial and industrial
loans have fallen in the last year) are purchasing large amounts of U.S. treasury securities and other
financial assets not counted in M2. These flows in response to opportunity costs do not change the
fact that monetary policy has been stimulative. In addition to monetary stimulus, other factors set
the stage for a stronger expansion, including lower unit labor cost increases and moderating inflation,
declines in real estate prices, a reduction of consumer debt relative to income, and strong growth
in corporate profits and improving business balance sheets.
Recent Economic Conditions. The improvement in economic performance in the second
half of 1992 was broad-based. Consumer confidence jumped, and strong department store sales
and healthy auto purchases contributed to 4.2 percent annualized growth in consumer spending.
Residential investment continued to increase. Real exports rose at a 9.5 percent annualized rate,
despite deteriorating conditions in Europe and Japan. In response to the marked pickup in product
demand, industrial production jumped and business inventory building grew. Business investment
in producer durable goods equipment continued to grow robustly. As a result, final sales grew at
a 4 percent annualized rate, 5.2 percent in the fourth quarter. Total nonfarm payrolls rose modestly
and manufacturing employment troughed after a sustained decline.

Shadow Open Market Committee

During the second half of 1992, nominal GDP growth accelerated to 6.2 percent. The implicit
GDP deflator declined to 2.1 percent from 3.1 percent in the first half of 1992. Part of this decline
reflected the rapid pickup in business investment in information processing equipment, whose
declining prices suppress the implicit deflator; the GDP fixed weight deflator rose 2.9 percent. This
acceleration of nominal GDP combined with the decline in M2 generated a pickup in M2 velocity
while Ml velocity continued to decline.
Productivity-driven Growth. A common complaint is that the recovery has been slower
than recent recoveries and has not created jobs. In fact, most of the increase in economic output
has been attributable to productivity gains, while employment growth has been modest The rapid
gains in productivity (productivity in nonfarm business sector has increased 3.1 percent in the last
year) are highly encouraging; the factors underlying the gains and the benefits they provide create
a strong base for sustained economic growth, including permanent job growth.
Widespread anecdotal evidence suggests that a portion of the productivity gains involves an
increase in the permanent efficiency of production in a number of industries. Marked changes have
occurred in both management behavior and objectives, and businesses have consolidated and
reorganized labor inputs, while investing heavily in productivity-enhancing equipment. This has
involved sizable layoffs at certain large firms. The fact that in the past year total nonfarm
employment has risen 0.7 percent despite these highly publicized layoffs is a very positive sign;
presumably, the new jobs provide higher value added than those that were shed.
The productivity-driven growth has a highly favorable impact on economic performance. It
has increased output while easing pressure on wage compensation, thus generating a dramatic
decline in unit labor cost (ULC) increases from 5.3 percent in 1990 to 0.7 percent in the last four
quarters. Real wages have declined and core inflation has improved; in the last year, excluding
food and energy, the PPI rose 1.7 percent and the CPI 3.4 percent, the lowest rate since 1973. In
addition, because ULC inflation has fallen faster than product price inflation, profit margins have
widened significantly and corporate profits and cash flow have soared; in the last four quarters,
operating profits have risen 26.3 percent and net cashflow12.4 percent. Moreover, the productivity
gains have raised the international competitiveness of U.S. firms, supporting continued growth in
exports.
These favorable economic fundamentals have contributed to the decline in interest rates and
the beginning of aflatteningof the yield curve, and provide support for the U.S. dollar exchange
rate and the stock market. Productivity gains lower core inflation and reduce credit demands that
normally accompany stronger growth, which mitigates the upward pressure on short-term interest

March 7-8,1993

rates. The decline in rates and firm stock market reduce the cost of capital either through equity or
debt issuance. All of these fundamentals provide an important foundation for sustained economic
expansion.
The Outlook. Real GDP is projected to expand approximately 3 percent-3.5 percent in 1993.
The recent decline in interest rates is a positive factor, suggesting stronger rather than weaker growth.
Consumption growth is expected to moderate to 2.5 percent-3 percent from its rapid 4.2 percent
pace in the second half of 1992, in line with the projected growth of real disposable income.
Employment willrisemodestly, approximately 1.5 percent (excluding the temporary summer jobs
programs) and real wages are expected torise,reflecting the sustained productivity gains, despite
continued slack in labor markets.
Business investment is projected to contribute to the healthy growth. Investment in producer
durable goods is expected to accelerate above 1992's growth of 9.3 percent reflecting increasing
product demand, strong corporate cash-flows and low costs of capital, business confidence, and the
Clinton Administration's proposed temporary marginal investment tax credit. As proposed, the
ITC would be retroactive to December 1992; its temporary nature will hurry-up certain business
investment plans. The large inventory overhang of office space suggests that business investment
structures will continue to decline, but it is expected to fall at a lesser rate than in 1992. Given
rising confidence in the economy, higher business investment in inventories is projected to add
gradually to national output.
The net export deficit is projected to remain unchanged or widen modesdy, having a neutral
to modesdy negative impact on real GDP growth. Exports are projected to continue growing at a
healthy rate, but imports will grow as fast, if not faster, with the economic pickup. From fourth
quarter 1991 to fourth quarter 1992, real exports rose 5 percent, but import growth accelerated to
9.6 percent. The rapid growth in imports reflects the higher imports of producer durable goods
equipment, particularly information processing equipment, as well as consumer goods.
In recent years, many people have consistently underestimated the ability of U.S. industry to
export, based on the unfortunate but common perception that it is not "competitive," and more
recent concerns about recessionary conditions among major trading partners, particularly Germany
and Japan. However, U.S. unit labor costs are lower than in major industrialized nations, including
Germany and Japan, and the recent productivity gains and slow wage growth in the U.S. has widened
that advantageous gap. In 1991-1992, U.S. export growth to developing nations has accelerated,
reflecting their strong economic growth, which has more than offset the slower growth in exports

Shadow Open Market Committee

to the industrialized nations. This trend is projected to continue in 1993. Strong growth of exports
to developing nations is expected to offset weaker export growth to the developing nations until
economics rebound in Europe and Japan.
Impact of President Clinton's Economic Proposal. The proposal should have a modest
beneficial impact on economic growth in 1993. In addition to the investment incentives, the
temporary jobs programs and quick infrastructure spending programs would temporarily lift job
growth and consumer spending. Insofar as the stimulus package is perceived to be temporary, it is
unlikely to lift overall confidence in the economy, particularly with sharply higher taxes looming
in 1994. The recent decline in interest rates, if they persist, should offset any negative impact the
higher deficits and anticipated tax increases. The proposed increases in public infrastructure would
offset the negative impact of the planned reductions of defense spending. As planned, this stimulus
package will be enacted and put in place immediately, well before the deficit-cutting proposals are
enacted and implemented. This provides a temporary boost to the short-term economic outlook,
but it does not add permanently to aggregate demand.
Its economic impact turns negative in 1994 with implementation of significant tax increases
and certain spending cuts. This proposal includes higher taxes in fiscal year 1994 of $27.7 billion
on personal income. $2.8 billion on payrolls (through eliminating the taxable maximum on he HI
portion of FICA taxes), $2.7 billion on social security benefits, and $7.7 billion on corporate income.
The new energy tax is estimated to raise only $1.5 billion in FY 1994 because it would not become
effective until July 1994 (thus affecting only one-quarter of the fiscal year); its revenue impact
would jump to an estimated $8.9 billion in FY 1995.
Although most of the personal income tax increases would be assessed on high income
individuals and would have a significant affect on saving, they would dampen consumption. The
broad-based energy tax would have a similar aggregate impact on disposable income and consumption as higher oil prices. Energy consumption is relatively price elastic in the short run, so
this tax would slow consumption. Its cumulative $49 billion tax increase in 1994-1997 is close to
1 percent of GDP. Coupled with the higher corporate income taxes, the new tax on BTU usage
would have a significant adverse impact on energy-intensive manufacturers. The resulting higher
operating costs and lower retained earnings would adversely affect their international competitiveness and perhaps slow employment growth. This impact would be partially offset by businesses
that take advantage of the temporary marginal ITC.

March 7-8,1993

The underlying strength of the economy suggests that beginning in 1994, this economic
proposal would slow the rate of economic growth and affect its mix, but not generate recession.
Consumption growth would be reduced while business investment would be boosted through 1994
as businesses take advantage of the investment subsidies. Government purchases would be relatively
unchanged in the aggregate, as the sharp increases in public infrastructure would be offset by the
planned sharp reductions in defense spending. The shift wold have a sizable adverse impact on the
defense industry and regions that rely heavily on military activities, and a positive impact on regions
targeting for infrastructure projects, particularly large old urban areas. After 1994, when the
temporary investment incentives expire, the environment for private investment is hurt, while the
full phase-in of the higher taxes continue to reduce disposable income.

Shadow Open Market Committee

;

1992

QUARTERLY DATA
Nominal GDP
GDP
GNP
Domestic Demand
Final Sales
Consumption
Residential Investment
Business Investment
Inventory Investment
Government Spending
Exports
Imports
GDP Deflator
1 Employment Costs (Private)
Unit Labor Costs (Non-Farm)
Productivity (Non-Farm)
Compensation (Non-Farm)
Corporate Profits A/T
Operating Profits A/T
Net Cash Flow
1 Current Account

(a)
(a)
(a)
(c)

III

5840.2
4873.7
4890.7
4895.2
4886.3
3289.3
185.6
495.8
-12.6
937.0
565.4
586.8
117.7
113.0
134.6
110.6
148.9
229.7
247.6
495.6
-5.9

5902.2
4892.4
4899.1
4936.3
4884.6
3288.5
191.2
514.7
7.8
934.2
563.4
607.3
118.7
113.8
134.9
111.1
149.9
232.7
244.3
504.3
-17.8

5978.5
4933.7
4945.6
4986.4
4918.7
3318.4
191.3
518.7
15.0
943.0
575.9
628.6
119.2
114.7
135.3
111.8
151.3
222.2
242.3
508.1
-14.2

I ...I...

6082.1 I
4991.5
NA
5039.4
4981.5
3357.7
202.7
531.1
9.9
938.0
589.5
637.4
119.9 I
115.7
135.5
112.9
153.0
244.4
280.7 !
521.4
NA_

4.3
1.5
0.7
3.4
-0.1
-0.1
12.6
16.1
N/A
-1.2
-1.4
14.7
3.4
2.9
0.9
1.8
2.7
1.3
-1.3
1.8
-47.6

IH
5.3
3.4
3.9
4.1
2.8
3.7
0.2
3.1
N/A
3.8
9.2
14.8
1.7
3.2
1.2
2.5
3.8
-4.5
-0.8
0.8
14.3

1
I
7.1 I
4.6
4.8
1.6
NA
1.4
4.3
1.7
5.2
1.3
4.8
2.0
26.1
13.1
9.9
-2.2
N/A
N/A
-2.1
-0.9
9.8
9.6
5.7
9.9
2.4
2.3
3.5
4.2
0.6
1.6
4.0
2.5
4.6
4.1
10.0
6.2
15.8
8.5
2.6
10.0
NA
-72.4

1992
Nov

Dec

Jan

50.7
54.7
55.4
58.0
Purchasing Managers Index
Non-Farm Payrolls
(b) 108.571 108.646 108.736 108.842
18.046
18.068
18.061
18.095
Manufacturing Payrolls
(b)
7.4
7.3
7.3
7.1
Unemployment Rate
(c)
34.5
34.6
34.4
34.4
Average Workweek (sa)
10.65
10.71
10.69
10.74
Avg. Hourly Earnings (sa)
8.3
8.2
8.7
8.6
Total Unit Auto Sales
6.3
6.2
6.7
6.6
Domestic Unit Auto Sales
109.7
110.3
110.5
111.0
Industrial Production
79.0
79.3
79.3
79.5
Capacity Utilization
123.3
123.2
123.3
123.6
PPI
135.1
135.3
135.5
136.1
PPI Ex. Food & Energy
141.7
142.0
142.2
142.9
CPI
148.9
149.3
149.6
150.3
CPI Ex. Food & Energy
165.6
165.4
166.8
167.4
Retail Sales
1226
1226
1285
1192
Housing Starts
1139
1126
1201
1180
j Permits
-48.8
-32.7
-38.9
29.8
| Federal Budget
(d)
125.3
123.3
135.1
132.8
| Durable Goods Orders
244.8
243.4
256.2
NA
' Manufacturing Orders
4125.7
4118.5
4157.6
4163.9
Personal Income ($87)
3346.7
3349.3
3377.1
3374.4
Consumption ($87)
4.7
4.4
4.5
4.6
Personal Saving Rate
(c)
149.2
150.2
152.8
152.9
1 Leading Economic Indicators
836.8
838.2
841.2
NA
Total Business Inventories
1.49
1.48
1.46
NA
Inventory/Total Sales
(c)
-7.3
-7.3
-7.0
NA
Merchandise Trade
(c)
2.90
3.21
3.32
3.13
3 Month Bill
(c) |
4.08
4.58
4.67
4.39
2 Year Note
(c) {
6.59
6.87
6.77
6.60
10 Year Note
(c)
7.53
7.61
7.44
7.34
I] 3 0 Year Bond
(c) I
3198.7
3238.5
3303.2
3277.7
DJIA
412.50
422.84
435.64
435.23
S&P 5 0 0
85.0
90.0
90.5
92.4
U.S. Dollar (FRB)
121
124
124
125
Yen/$
1.49
1.59
1.58
1.61
DM/$
1005.9
1019.1
1026.6
1033.3
I M1
3496.9
3505.6
3504.0
3492.3
M2
4186.2
4188.4
4176.4
4149.3
M3
745.9
751.2
746.1
NA
C&l Loans & Non-Financial CP
722.4
723.4
725.9
NA I
il Consumer Credit

Monthly % Change

1992
Oct

6.2
2.9
3.6
3.0
4.7
5.1
20.1
3.0
N/A
1.7
2.9
3.5
2.8
4.0
0.0
3.7
3.7
10.8
11.4
6.8
5.3

Levels
MONTHLY DATA

Quarterly % Change (annualize
Yr-to-Yr % Change
1992
1992

Levels

Oct

Nov

Dec

Jan

4.1
74
-56
-0.12
0.6
0.2
-0.6
-1.1
0.7
0.5
-0.1
-0.1
0.4
0.5

7.9
75
22
-0.08
0.3
0.6
-1.4
-1.2
0.5
0.4
-0.1
0.1
0.2
0.3

1.3
90
-7
-0.03
-0.6
-0.2
5.8
7.3
0.2
0.0
0.1
0.2
0.1
0.2

4.7
106
34
-0.18
0.0
0.5
-0.3
-0.1
0.5
0.3
0.2
0.4
0.5
0.5

2.1
0.7
1.2
-12.2
4.6
2.0
0.8
0.6
0.31
0.3
0.2
-0.00
1.42
-13
19
17
19
-2.9
-1.4
3.7
-1.2
2.3
1.6
0.4
0.0
1.1
0.0

-0.1
0.0
-1.1
12.0
-1.6
-0.6
-0.2
0.1
-0.33
0.7
0.2
-0.01
-0.10
31
50
28
8
1.2
2.5
5.9
2.2
6.9
1.3
0.2
0.1
0.7
0.1

4.3
1.6
1.4
2.1
1.0
1.5
14.6
2.3
N/A
-1.2
5.1
9.7
2.9
3.7
0.8
2.5
3.3
11.1
8.9
11.9
-80.9

III
4.6
2.1
2.1
2.5
1.8
2.1
10.8
4.0
N/A
0.3
5.8
9.2
2.5
3.4
0.7
2.7
3.4
6.0
13.1
11.1
-12.6

1
1

IV
5.7
3.2
NA
3.7
3.1
3.3
14.3
7.9
N/A
0.5
5.0
9.6
2.6
3.4
0.7
3.0
3.7
17.8
26.3
12.4
NA

12 Month % Change
1992
Oct

-4.7
0.3
-1.9
0.46
0.6
2.4
0.5
3.9
1.2
-1.0
1.3
1.9
3.2
3.5
0.8
0.3
7.2
4.8
-7.2
12.2
14.6
6.7
-1.7
-302
-36.4
45.5
9.6
-1.7
4.2
5.3
NA
2.6
1.0
0.2 j
2.1
0.8
-0.1
3.3
0.17
0.03
-0.57
1.7
0.1
2.8
0.4
NA
1.5
-0.02"
NA
-0.03
0.40
NA
-1.38
11
-19
-228
9 - 2 8
-183
-10
-17
-94
-40
-17
-10
5.9
2.0
-0.8
6.6
3.0
-0.1
-6.2
0.5
2.1
-7.3
0.1
0.8
-0.3
2.0
-12.1
0.7
0.7
14.4
-0.0
-0.3
2.2
-0.3
-0.6
0.7
-0.7
NA
-1.2
0.3
NA

Nov
9.4
0.5
-1.6
0.40
0.6
2.8
-1.4
0.8
2.0
0.0
1.0
1.8
3.0
3.4
7.3
13.2
15.0
-290
2.4
2.0
2.3
3.1
-0.27
3.7
1.7
-0.04
-3.23
-152
-98
-55
-31
8.5
9.6
2.3
-4.4
-2.1
14.4
2.0
0.6
-0.8

Dec

Jan

17.1
18.9
0.5
0.7
-1.5
-1.0
0.13 -0.04
-0.3
0.3
2.2
2.7
7.3
6.3
11.1
10.5
2.9
4.1
0.8
1.9
1.3
1.5
1.8
1.7
3.0
3.2
3.4
3.4
7.9
6.6
17.5
2.4
11.9
6.7
-327
-281
18.6
12.5
11.4
NA
2.2
2.6
3.7
2.5
-0.95
0.16
5.6
4.5
1.7
NA
-0.09
NA
-1.33
NA
-92
-81
-36
-57
-32
-43
-26
-24
11.6
1.6
12.1
4.6
5.7
7.3
-3.1
-0.4
1.2
2.3
14.2
13.4
1.7
1.2
0.2
-0.5
-0.6
NA

1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1

^^^••^•••••••••••••••••••••••MBMBi
(a)
(b)
(c)
(d)

Quarterly % changes are not annualized
Monthly changes are in levels
All changes are in levels or basis points
Monthly: change from same month last year;

Annual: sum of past 12 months

41
05-Mar-93

March 7-8,1993

Chart 1
SELECTED ECONOMIC INDICATORS

Industrial Production

Retail Sales
175

5.0%
4.0%

170

3.0%

165
2.0%

160

0.0%
-1.0%

evel

ate ofCh

1.0%

•8

155

o
150

-2.0%

145

-3.0%

140
-4.0%
89

02-Mar-93

JUL
90
JUL
91
JUL
92
JUL
93
APR
OCT
APR
OCT
APR
OCT
APR
OCT

135

9.0%

' -

Lhr\\ H '

Housing Starts and Permits

1400
1300
1200

1100

109000

l\ ^ A
X
J>
C\ •s (AA
v* \ A S J
V
7
s/
\
r*\

900

JS 108500

/—

800

107500

APR

OCT

JUL
APR

OCT

JUL
APR

OCT

JUL
APR

c
1.0%
• ^

^—^ ^

0.0% »J

•

-1.0%

106500
JUL

4.0%

107000 h

700
89

0.0%

2.0%

108000

Ai ¥/y

1000

3.0%

109500

V \ \

2.0%

^_ Retail Sales (Thous.) Yr/Yr

r r-

110000 r

v '7

3.0%

U
o

Non-Farm Payroll Employment

4.0%

-2.0%

110500 K Tv

k1X V J I

JUL
90
JUL
91
JUL
92
JUL
93
APR OCT APR
OCT APR
OCT APR
OCT

1800

1500

5.0%

n 11 ill i nil 111111

111000 r n — ! — i — i — i — i — i — i — i — i — i — i — i — i — i — i — n

1600

6.0%

1.0%

1900

1700

8.0%
7.0%

-1.0%

— Retail Sales (Thous.)

Yr/Yr

ii I \m

M
M
1
h
ft
1
L
I
HUA
WT
rM
W4I!
rrf T\f MT r
89

Industrial Production Index (SA, 1987=100)
_•- Industrial Production Index (SA, 1987=100)

-2.0%
89

OCT

JUL
90
JUL
91
JUL
92
JUL
93
APR OCT APR OCT APR OCT APR OCT

-Total Nonagricultural Payrolls (SA, Thous.)
-Total Nonagricultural Payrolls (SA, Thous.) Yr/Yr

Housing Starts, Total (SAAR, Thous.Units)
-•_ Housing Permits (SAAR, Thous.Units)

Disposable Income

Corporate Profits
600

9.0%

4700
4600

•

4500
4400
4300

111 MAN UfjT
1 Mffllltft!

8.0%

7.0%

mt'll
Mr
Mi L \\W\
M

4000
3900
3800
3700
3600

5.0% etf

1 \\V\

300

6.0%

4.0%

[

- ^
400

_ 4200 I> 4100

500

X. ^J

'**+*

200

3.0%

3500
89

JUL
90
JUL
91
JUL
92
JUL
93
APR OCT APR OCT APR OCT APR OCT

Disposable personal income (SBil)
http://fraser.stlouisfed.org/
-•- Disposable personal income (SBil) Yr/Yr
Federal Reserve Bank of St. Louis

100
83

Net Cash Flow w/IVA and CCA
-*- Corporate Profits w/IVA and CCA —Economic Profits

04-MarShadow Open Market Committee

Chart 2

Real Exports and Imports
700
I

i !

**
600 i-

500

400

300

200
80

Real Exports ($87)

_ ^ _ Real Imports ($87)

Composition of Real Merchandise Exports and Imports
91:IV
Level

92:IV
In $ Bil

Percent of
Total

Percent Change
1991:IVto1992:IV

425.5
38.3
93.6

100.0

4.5

9.0

14.7

Industrial Supplies

407.3
33.4
96.4

22.0

-2.9

Capital Goods, (Ex. Auto)

172.5

183.7

43.2

6.5

Auto

37.5

42.8

10.1

14.1

Consumer

42.7

45.4

10.7

6.3

Other

24.9

21.6

5.8

-13.3

Imports

482.2

532.6

100.0

10.5

Food, Feed, Beverages

24.5

25.6

4.8

Industrial Supplies

69.1

72.5

13.6

4.5
4.9

129.3

160.4

30.1

24.1

78.3

79.9

15.0

104.6

110.3

20.7

Other

29.8

31.3

Petroleum

46.5

52.6

5.9
9.9

2.0
5.4
5.0

Exports
Food, Feed, Beverages

Capital Goods, (Ex. Auto)
Auto
Consumer

13.1

Chart 3
02-Mar-93

Employment, Growth and Productivity
(Year-to-Year Percent Changes)

GDP

Employment _^_ Productivity

02-Mar-93

Shadow Open Market Committee

Chart 4
PRODUCTIVITY, UNIT LABOR COST & COMPENSATION

Productivity
120

4.0%

115

110

3.0%

2.0%

^ A

o
00

s05

105

1.0%

<*-

o
o

100

0.0%

-1.0%

-2.0%

_ Nonfarm Business Sector: Output Per Hour of All Persons (SA, 1982=100)
_ Nonfarm Business Sector: Output Per Hour of All Persons (SA, 1982=100) Yr/Yr

Unit Labor Cost Inflation
150

11.0%
10.0%

140 U

9.0%
8.0%

130 h

7.0%
6.0%

120 h
5.0%
4.0%

110 h

3.0%
100

2.0%

1.0%
90

0.0%

Nonfarm Business Sector: Unit Labor Cost (SA,1982=100)
Nonfarm Business Sector: Unit Labor Cost (SA,1982=100) Yr/Yr

Compensation
170

9.0%

160
150

8.0%

140 r-

110

100

130 \\120

7.0%

6.0%

X,-*<

^ -

5.0%

•

4.0%
3.0%

90
82

J
U

labor compensation per hour: non-farm business sector
labor compensation per hour: non-farm business sector Yr/Yr

2.0%

Chart 5
02-Mar-93

MEASURES OF INFLATION

Producer Price Inflation

Consumer Price Inflation
25.0%

20.0%

20.0%
15.0%

g
o

10.0%

5.0%

mi
M
irk VINTn M i l
Trrf

0.0%
70

72
71

J LL4J
MTrtjtnm

74
73

76
75

78
77

80
79

82
81

84
83

88
85

90
89

92
91

90
92
89 " 91
93

CPI-U, AH Items (NSA, 1982>84=100) Yr/Yr
CPI-U: ALL ITEMS, EX. FOOD AND ENERGY (NSA) Yr/Yr

PPI: Finished goods (to users,incl. foods, fuel) (1982=100,NSA) Yr/Yr
PPI: Finished Goods Less Food and Energy (NSA, 1982=100) Yr/Yr

Implicit GDP Deflator

Fixed Weight GDP Deflator
1978 - Present

13.0%
11.0%

12.0%
11.0%

10.0%

9.0%

8.0%

\ 8.0%

^ 7.0%

7.0%

§ 6.0%

6.0%

5.0%

\
\

S~^

4.0%
4.0%

3.0%

2.0%

v-V

-/ *-»

VV "

1.0%
70

GDP Implicit (Yr/Yr)

Fixed Weight GDP (Yr/Yr)

Shadow Open Mtket Committee
Chart 6
MEASURES OF MONEY SUPPLY

04-Mar-93

Bank Reserves
60

Currency

50 Y
,—M

-'"-

40 Vk

jy \ Jf*J</

Bank Reserves (Adj., SA)
^-Bank Reserves (Adj., SA) Yr/Yr

— Currency (SA)
-•_ Currency (SA) Yr/Yr
-*- Real Currency (SA) Yr/Yr

Monetary Base

M1
1100

20.0%

1000

15.0%

900

10.0%

-J

800

— /wH^

5.0%

—

700

0.0%

600

-5.0%

500

Monetary Base (Adj.,SA)
->- Monetary Base (Adj.,SA) Yr/Yr

-10.0%
86

_ M1 (SA)

+ M1 (S A) Yr/Yr

_ Real Ml (sa) Yr/Yr

M3
15.0%

10.0%

10.0%
5.0%
00

5.0%

o
o
0.0%

0.0%

-5.0%

-5.0%
86

_ M2 (SA)

— M2 (SA) Yr/Yr

. Real M2 (sa) Yr/Yr — M3 (SA)

-+- M3 (SA) Yr/Yr

-*. Real M3 (sa) Yr/Yr

Chart 7
MONEY VELOCITY

04-Mar-93

Monetary Base Velocity

M1 Velocity
8.5

L Y

,J
' \J

7.5

6.5

i
\

V>\

5.5
r~^

/
4.5

4
68

Base Velocity

Ml Velocity

M3 Velocity

M2 Velocity
1.9
1.8

/ \<\

/
\

1.7

P Vi

1.6

^ \ \

\J- •

1.5

V \S\1

1.4

1.3

1.2
1.1
68

M 2 Velocity

M3 Velocity

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March 7-8,1993

Shadow Open Market Committee

SOME OBSERVATIONS ON MONETARY BASE
GROWTH DURING RECOVERIES
Charles I. PLOSSER
William E. Simon Graduate School
of Business Administration
University of Rochester

There is continuing pressure on the Federal Reserve to further ease monetary policy to promote
economic recovery. Since the peak of this most recent business cycle in July 1990, short-term
interest rates have fallen by almost 500 basis points and the monetary base has grown at an average
rate of almost 11 percent per annum. By almost any measure, the Federal Reserve has been very
aggressive with the instruments under its control to promote economic recovery.
Growth in the monetary base, however, is the principle engine for generating inflation and
historically had little impact on real economic growth. Figure 1 illustrates that annual growth rates
in the base have little or no association with real GDP growth. (Allowing for a lag of up to two
years does not significantly alter the picture.) On the other hand, higher monetary base growth is
systematically associated with higher rates of inflation. Partitioning annual base growth into periods
in which it was less than 5 percent and periods in which it was greater than 5 percent is summarized
in Table 1 and tells a similar story. The table shows that between 1960 and 1992 when the monetary
base grew faster than 5 percent year over year it averaged 7.3 percent and that real GDP growth
averaged 2.8 percent and inflation averaged 5.2 percent. When the monetary base growth was less
than 5 percent, year over year real GDP still averaged 2.8 percent while the average inflation rate
fell to 2.9 percent.
Figure 2 reproduces Figure 1 except that it only plots the three years following an economic
trough. Once again, the qualitative picture is the same: faster base growth appears unrelated to
real economic growth but positively related to inflation rates. The graphs of Figure 3 plot the path
of real GDP, the price level and the monetary base for each recovery since 1960. Each variable is
indexed to 100 in the quarter of the trough and its evolution is plotted for 12 quarters or 3 years.
In five of the six recoveries, high base growth has resulted in higher price growth while lower base
growth has been associated with lower price growth.1 The only exception appears to be the current
recovery to date. Extremely rapid base money expansion has occurred since the trough in 1991-1
yet prices have only grown modestly. History gives cause for alarm regarding the prospects for

March 7-8,1993

inflation if the Federal Reserve does not bring a stop to this very rapid expansion in the monetary
base. Since January 1st of this year, the monetary base has grown at an annual rate in excess of 25
percent!
We also continue to hear reports from Washington and the business press that either more
economic growth causes inflation or that inflation is good for economic growth. Neither story has
much evidence to support it. Figure 4 plots the annual growth rate in real GDP against the annual
inflation rate along with the least squares regression line over the 1960-1992 period. There appears
to be no indication that high economic growth is systematically associated with higher rates of
inflation. If anything, the picture indicates that higher inflation rates are more frequently associated
with lower rates of real economic growth.
Table 2 partitions the sample into those periods of annual inflation greater than 5 percent and
less than 5 percent. When annual inflation was greater than 5 percent, real GDP grew at an average
rate of 2.9 percent. When annual inflation was less than 5 percent, real GDP grew at an average
rate of 3.3 percent. Neither the Federal Reserve nor the Administration should attempt to resurrect
the Phillips Curve as basis for policymaking.
Since the announcement of Clinton's economic program there has been a drop in long-term
interest rates. Most commentators have interpreted this as indicating support for the President's
economic proposals and confidence that the deficit will be reduced some time in the future. It is
worth noting that long-term rates have been falling since early December. Long-term Treasuries
have fallen 80-90 basis points. The term spread has declined from over 400 basis points in December
to about 360 basis points in late February. Nevertheless, since Clinton's announcement of his
economic program, long-term rates have continued to fall and short-term rates have stabilized.
There are other interpretations one may wish to consider depending on whether one views
the fall as a reduction in expected future short-term real rates or only in nominal rates. One possible
explanation is that tax increases that reduce the future deficit may reduce the pressure on the Federal
Reserve to monetize the debt and thus create inflation. If so, then the reduction in long-term nominal
rates is simply a reduction in expected inflation and not a reduction in real rates. Another explanation
is less charitable to the Clinton economic plan. It is well-known that the slope of the yield curve
is a valuable predictor of future real economic growth. Thus another interpretation is that the
flattening of the yield curve is signaling that real rates are expected to be lower in the future because
the tax proposals of the new Administration will act to reduce economic growth in the longer term.
It is dangerous, therefore, to be too sanguine regarding the behavior of the bond markets and its
response to the current economic proposals.

Shadow Open Market Committee

NOTES

Also plotted for the last three recessions is the domestic base which nets out foreign holdings

of U.S. currency. The message remains the same even for the current episode.

March 7-8,1993

Table 1
Annual Growth Rate of Monetary Base
< 5.0%

> 5.0%

Average Base Growth Rate

3.4%

7.3%

Average Real GDP Growth Rate

2.8%

Average Inflation Rate

2.9%

5.2%

Table 2
Annual Inflation Rate
<5.0%

> 5.0%

Average Base Growth Rate

6.0%

7.5%

Average Real GDP Growth Rate

3.3%

2.9%

Average Inflation Rate

3.2%

5.3%

Shadow Open Market Committee

REAL GDP, INFLATION AND THE MONETARY BASE
1960 - 1992
REAL GDP AND MONETARY BASE GROWTH
0.100
Q

0-075

~
O

0.050

0.025

0.0004

a:
w
«

-0.0254

>«

-0.050
0.000

0.025

0.050

0.075

0.100

0.1

YEAR OVER YEAR GROWTH OF MONETARY BASE

INFLATION RATE AND MONETARY BASE GROWTH
0.125as

0.100

o
as

0.075

0.050
(X

0.025 A

0.000

0.025

0.050

0.075

0.100

0.125

YEAR OVER YEAR GROWTH IN MONETARY BASE
FIGURE 1

March 7-8,1993

REAL GDP, INFLATION AND THE MONETARY BASE
DURING ECONOMIC RECOVERY
REAL GDP AND MONETARY BASE GROWTH
o.ioo
Q

0.075
•

•

0.050
O

o
as

•

•*

•

M
0.025-1

•

0.000 J
OS
W

-0.025 J
-0.0500.000

0.025

0.050

0.075

0.100

YEAR OVER YEAR GROWTH IN MONETARY BASE

INFLATION RATE AND MONETARY BASE GROWTH

0 100:

:•

•

0.075• ! **
•

•

^\
^ ^ ^ \

0.050 H
OS
W

5
3

0.025 J

•....:
^ ^ " ^

: •

0 000-1
0.(300

*...

f"^

•

N
*

•
•
•

•

0.025

0.()50

•

0.075

0.1 00

YEAR OVER YEAR GROWTH IN MONETARY BASE
FIGURE 2

TROUGH 1975-1

TROUGH 1970-IV

TROUGH 1960-1

_I__I

TROUGH 42
41

44
4*

*
46

*%
47

*10
40

412
*11

TROUGH +2
•1
43

REAL GOP PRICES BASE

•10
»

«11

TROUGH 1980-111

i—1_
410
412
411

REAL GDP PRICES BASE

REAL GOP PRICES BASE

Figure 3.1

TROUGH 42
44
41
43

412

Figure 3.2

Figure 3.3

TROUGH 1982-IV

TROUGH 1991-1

130

12S

IIS

110

105

—^yC^^^^^..

.„....^&g**<Z....-.„

100

TROUGH • !
•1

44
43

«•
46

4i
47

+10
40

412
411

REAL GOP PRICES BASE DOM. BASE

Figure 3.4

•*TOOUGH
•1

44
43

46
4$

46
47

410
40

REAL GOP PRICES BASE DOM. BASE
H»-4-O-B-

Figure 3.5

05' I '
'
TROUGH 42

412
411

•
•10
43

+12
411

REAL GDP PRICES BASE DOM. BASE

Figure 3.6

March 7-8,1993

REAL GDP GROWTH AND INFLATION
1960 - 1992
0.1001
0.075 A

0.050-1
0.025 J
0.000 J

-0.025 J
-0.050
0.000

0.025

0.050

0.075

0.100

YEAR OVER YEAR INFLATION RATE

Figure 4

0.125

Shadow Open Market Committee

REAL GDP GROWTH AND INFLATION
DURING ECONOMIC RECOVERY
o.ioo
0.075-1

0.050-1

:-i*.--*i
•

0.025 J
0.000

;

•

•...„7TSww iS ..

:...

• !
•

;

-0.025 J
-0.050
0.000

•

0.025

*:
•

•

••

i
i

\
•

J
•!
:

•

0.050

0.075

V--*--i•

*..:...
:«

0.100

YEAR OVER YEAR INFLATION RATE

Figure 5

0.125

March 7-8,1993

Shadow Open Market Committee

THE COMPETITIVE POSITION OF THE UNITED STATES IN THE
INTERNATIONAL ECONOMY
William POOLE*
Brown University

What was the international competitive position of the United States at the outset of the Clinton
Administration? What can we learn from recent performance and policies of other major economies
around the world? These are big questions, but a relatively few graphs can go a long way in providing
a sense of where the U.S. economy stands.
PRODUCTIVITY AND UNIT LABOR COSTS
Figure 1 shows what has happened to unit labor costs in manufacturing since 1987 for the
United States and a handful of other countries. The black bar shows the data in local currencies,
and the gray bar the data converted to a common currency using 1992 exchange rates. U.S. unit
labor costs in manufacturing have risen by only 4 percent since 1987. With the exception of France,
our major competitors have done worse, and in some cases much worse. Taking account of exchange
rate changes since 1987, the U.S. has done far better than any of its major competitors; U.S. unit
labor costs have fallen 23 percent. We should not be surprised that U.S. net exports have risen
substantially over this period; the U.S. balance-of-payments current account was -$163 billion in
1987 and only -$3.7 billion in 1991.
Figure 2 shows the long-term record of U.S. unit labor cost and productivity in the private
business sector. The figure shows the private business sector rather than just manufacturing because
trade in services is growing rapidly, and trade in agricultural products has long been important to
the United States. The dramatic improvement over the last several years is clearly evident. Over
the four quarters ending 1992:IV, compensation rose by 3.69 percent, output per hour by 3.26
percent, and unit labor cost by only 0.67 percent. In manufacturing, over the four quarters ending
1992:IV, compensation rose by 2.49 percent, output per hour by 3.26 percent, and unit labor cost
fell by 0.73 percent.

March 7-8,1993

OUTPUT
Figure 3 shows what has happened to industrial production since 1987. The United States
has only just recently seen its industrial production surpass its peak in 1990. Production in OECD
Europe as a whole flattened out in 1990, but has now fallen below U.S. production, relative to the
base year of 1987. Japan's production rose to a much higher peak in 1991 than did U.S. production,
but the decline in Japan has been much steeper than it was in the United States. Canada reached a
peak in 1989, and is still far from recovering to its peak level of production. Overall, the performance
of the United States is at least comparable to that of its major competitors. A rosier view would
note that the United States has enjoyed a sustained increase in production since late 1991, whereas
many other countries have flat to falling production.
Figure 4 shows the longer-term growth record as measured by real GDP. The data in the
figure were drawn from the World Bank, World Development Report 1992, which has the virtue
of reporting a very large number of countries but the disadvantage of not being totally up to date.
In Figure 4, the United States and the United Kingdom are the only two countries to show higher
growth over the 1980-90 period compared to the 1965-80 period. For the United States, growth
averaged 2.2 percent 1980-92, down from 2.7 percent 1965-80. Still, given that most countries in
the developed world suffered low or negative growth 1991-92, the relative improvement of U.S.
growth after 1980 still stands. On an absolute level, U.S. growth 1980-90 was 3.4 percent, which
was higher than any other country in the figure except for Japan, at 4.1 percent. (Australia, Canada
and Finland also came in at 3.4 percent growth.)
THE LABOR MARKET
The politics of economic performance often center on unemployment issues. Figure 5 shows
U.S. performance on this front. Between 1970 and 1980, unemployment rose in every country
shown in thefigure,except for Norway which was unchanged.1 Unemployment again rose in every
country between 1980 and the latest available data, which refer to 1992:111, except for the United
States and Belgium. On an absolute basis, U.S. unemployment was below that in many of our
international competitors.
The unemployment rate only scratches the surface of employment conditions. Figure 6 shows
unemployment of six months and longer as a percentage of total unemployment in 1990 (latest data
available to me in readily accessible form). Relative to other countries, U.S. unemployment is
short-term. In 1990, when the U.S. unemployment rate was 5.4 percent, only 12.4 percent of that

Shadow Open Market Committee

unemployment, or 0.67 percent of the labor force, was six months and over. In contrast, Germany,
for example, had an unemployment rate of 4.9 percent in 1990, but 64.5 percent of that unemployment, or 3.16 percent of the labor force, was six months and over. The U.S. labor market is
much more flexible than labor markets in most other countries.
Figure 7 reflects my interest in a growing problem in the United States, that of early retirement
of men aged 55-64. (I think it is a problem because people in this age group have valuable accumulated skills.) Of men in that age group, 34.7 percent were either not in the labor force or
unemployed, a concept the OECD calls the "inactivity rate." In fact, the United States compares
reasonably well to other countries on its inactivity rate for men 55-64, with the exceptions of Japan
and Sweden. In terms of the employment of women, shown in the figure for the age group 25-54,
the United States does better than most other countries (the U.S. inactivity rate is lower). Sweden
is the only country in the figure with a lower inactivity rate for women 25-54.
I put Sweden in thesefiguresnot because it is a large economy, which it obviously isn't, but
because by many measures it does very well on the employment-unemployment front. Figure 8
provides a hint as to how Sweden can accomplish this result. Sweden spends 0.2 percent of its
GDP on subsidized employment and 0.8 percent of its GDP on training programs for unemployed
adults. In 1990-91, unemployed adults entering training programs amounted to 1.7 percent of the
labor force in Sweden, compared to 0.9 percent for the United States.2 Given that Sweden spends
much more as a percentage of GDP on these programs than does the United States, it is presumably
the case that unemployed adults remain in training programs longer in Sweden than in the United
States. Training programs reduce reported unemployment, but in Sweden's case have not been
successful in achieving a high rate of growth of real GDP, judging from Figure 4.
An interesting feature of Figure 8 is the large differences among the countries shown in
unemployment compensation as a percentage of GDP. It is well-known that unemployment
compensation tends to reduce the incentive for unemployed persons to find new jobs; part of the
problem of high unemployment is that many OECD countries pay people too much for too long to
remain unemployed.

TAXES
President Clinton has proposed that the United States embark on a program of substantial tax
increases with the stated aim of reducing the federal budget deficit. It seems appropriate to ask
whether there is evidence that high-tax countries have smaller budget deficits than low-tax countries.

March 7-5,1993

Figure 9 shows the data on taxes and budget deficits for OECD countries in 1990. Government
is defined here as general government—central and lower levels of government combined. There
is no evidence in Figure 9 that countries with higher taxes as a percentage of GDP have lower budget
deficits.
Figure 10 explores the question of whether countries that increased their taxes the most over
the 1972-90 period were successful in reducing their budget deficits. Here again, the verdict is
negative. With the exceptions of Japan and Ireland, budget deficits have grown everywhere,
independently of whether countries increased their taxes a lot or a little. Given this evidence, given
that President Clinton is planning substantial increases in federal spending, and given the likelihood
that the increases in tax rates will yield less revenue than estimated at this time, I see no reason to
believe that the federal budget deficit will in fact fall to any appreciable extent.
Figure 11 provides information on top marginal personal tax rates for 1980 and 1990 (updated
to 1992 where I had information readily available). Almost all countries reduced tax rates in the
1980s, but as of 1992 the United States still had the lowest top rate of the countries shown in the
figure with the exceptions of Canada, Norway, Sweden, and Switzerland.
Figure 12 provides information on capital taxation. Many countries have a zero tax on capital
gains, but most tax dividends at a higher rate than does the United States. There is much to be said
for taxing dividends and capital gains at the same,relativelylow rate.
I believe that it is no accident that countries with high tax rates in the 1980s experienced
higher unemployment and slower growth, on the whole, than did the United States.

CONCLUDING COMMENTS
The performance of the U.S. economy was certainly less than robust 1990-92, but relative to
other nations the United States has not done badly. The impatience of the Clinton Administration
and its desire to raise taxes tofinancenew spending programs promises to damage U.S. economic
prospects. The fiscal program of stimulus now and higher taxes later is 1940s Keynesianism. In
fact, the depressing effects of future tax increases will arrive in 1993; the combination of fiscal
stimulus and restraint at the same time is equivalent to driving with one foot on the accelerator and
one on the brake. This policy is just as bad for the economy as it is for a car.

Shadow Open Market Committee

NOTES

*I thank Data Resources, Inc. for providing access to its data bank, from which I drew the
data for Figures 2 and 3.
lr

The data in the figure refer to OECD standardized unemployment rates, which adjust for

differences in national definitions to maintain comparability across countries.
2

OECD Employment Outlook, July 1992, Table 2.B.2.

March 7-8,1993

Figure 1 - Unit Labor Costs in Manufacturing, 1992
Selected Countries
Index. 1987 = 100

100

110

120

130

140

B In local currency El Relative, in a common currency
Source: OECD Economic Outlook, Dec. 1992, Table 18

Figure 2 - U.S. Productivity and Unit Labor Cost
Business Sector
Four-Quarter Change, 1947 -1992
Unit labor cost

2
0
-2
-4

Output/hr.
i n i i l l l ! m l m l i l : l l i i [ l l i l m In l i n i l m l i I i l m l m l m I m i n i li n l i n l i u i . ; . i.'iiiiilniliiiliul.tiiii i I I I I I I I I I I H I I I . I M I I I I i I m l n ,lm l i n l m l ,n!,, ,ln il,,, I, i,j,

1950

1955

1960

1965

1970

1975

1980

1985

1990

Shadow Open Market Committee

Figure 3 - Industrial Production, Monthly
United States, OECD Europe, Japan, Canada
1987-1992
1.30
1.25 h
Japan

1.20
o
o
"'- 1.15

OECD Europe

United States

Canada '••.• •.•
I I I l I I i I I I I I I I ', I l \ I I I I I I I I I I I 1 I I 1 1 I I 1 I 1 I M I I I I I I 1 I I i I I I I I I I 1 I I I I M I 1 I I I 1

1987

1988

1989

1990

1991

1992

Figure 4
Growth Rate of Real GDP, 1965-80 and 1980-90
Selected Countries
-•-•-— - *
Australia i i ^ — » f l M r — •
Belgium '"'"nil iii I' '•rf'"-'-"-" ""t ii' i iii" -•-•-•---•-—•---- ---------- -^-.----------^---.-.- -^-.-.--•----.---.--•.-------.-.---^..-.-.-.-.-_---.-.-.-.-.-,.,-.-.-.,-.-,.-.-.-.-.,-.i
Canada
Finland
;, ,
''.""'"";;:':;:'"''"'
France MmummmmamBBBmBam ''
Germany
nm^jmnm^
Italy
Japan [••• •••••--••••-• •-•••-•••••• •••••••• -•••••••••••••••• '•'•' •••••' " '-'•-•" "'"'• •liiiiiiijiiiiiiiiiiiiiiijy iiiiin liiimliiilii f
Netherlands
Norway
Portugal Spain r ~"""^^
i
— |-| iij|||||||[||iiiti - --- - •••••••*
Sweden
United States
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ZS
,
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«
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4
-

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•••-••-•-••••••• "' - •

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'' -'-•• •

•••»

v v

Percentage
1 3 1965-80

•

1980-90

Source: World Bank, World Development Report 1992, Table 2.

March 7-8,1993

Figure 5
Unemployment Rate, 1970,1980, and 1992:1
Selected Countries
Australia
Belgium
Canada

United States
United Kingdom

Percentage
1970

1980

1992:111

Sources: OECD Economic Outlook June, 1990 and December 1992, Table R 18.
OECD Main Economic Indicators, December 1992, p. 22.

Shadow Open Market Committee

Figure 6 - Unemployment Six Months and Over
As Percentage of Total Unemployment
Selected Countries, 1990
[
I

United States h M t t
France B g g ffltiM'^iB^
Japan ^ ^ H
Germany j j j g g g
United Kingdom t ^ ^ H

Italy p H j
uanaaa HBfSffj
Sweden ^ B n
0

Percentage
Source: OECD Employment Outlook (July 1992), Table N

Figure 7 - Inactivity Rates
(Percentage of Group Not Employed)
Selected Countries, 1990
United States
France
Japan
Germany
United Kingdom
Italy
B34.1

Canada

138.1

Sweden t
i

•'
l

113.6

50
30
40
Percentage
Males, 55-64 B Females, 25-54

Source: OECD Employment Outlook (July 1992), Table 2.7

HB25.6

March 7-8,1993

Figure 8 - Labor Market Programs, Selected Countries
1991 (or latest year available)
Percentage of GDP

United States

France

Japan

||| 0.1
0.0

Germany

United Kingdom

Italy

Canada

Sweden

0.5

1.5
Percentage

Unemployment compensation

Subsidized employment

Training for unemployed adults
[ • •

C ™ trr*Ck> r M Z / ^ R Cmr>l/-\wnnckn+ H i t+\rsr\lr f h ilw HOQO\

-- - U W U I W—
C . -V-CI_V>1-/

C l l likp i w y m c i t i

oKlo O R l
v/uuuwrv ^uuiy ic<y£y, iT£uJiC
£.D. J

2.5

Shadow Open Market

Committee

Figure 9 - General Government Receipts and Balance
OECD Countries, 1990
Percentages of GDP

-5

c
c

U.K.

France Austria

#
^ a l l a Spain #
#
Finland
•
%
Portugal Canada

I
CD

Norway
«

•
Sweden

Denmark

Netherlands
Belgium
#

Budget deficit

I U.S.
•

Ireland
•

dget
plus

c
CO

"5
"o
c

a) m ]

Japan
•

CD
O

•
Italy

f2 -15 h

Greece

1
c

-20
30

50
General government receipts

Source: OECD Economic Outlook 1992, Tables R14, R16

Figure 10 - Changes in General Government Receipts and Balance
OECD Countries, 1972 -1990
Percentages of GDP

s«

Japan

n
7g

i <

U.S.
#

c
CD

E -5
E

CD *-*•"

U.K.

^ Ireland

Netherlands

Austria
#

#
Canada

•

CD
c

Belgium

Norway

Germany

Italy

France

Australia
Denmark

Sweden •

Spain

a
a

Portugal

%
—*

£5 -10 h
CD
C
CD

CQ
CD

Finland
Greece

-15

CO
JZ

Change in general government receipts
Source: OECD Economic Outlook 1992, Tables R14, R16

March 7-8,1993

Figure 11 - Top Marginal Personal Tax Rates
(Central Government)
Selected Countries, 1980 and 1990
Australia*
Austria
Belgium

Canada*
Denmark*
Finland
France*
Germany*
Greece

Italy*
Japan*
Netherlands
New Zealand*

Norway*
Spain*
Sweden*
Switzerland
United Kingdom*
United States*

JMIHWUHIIH

Percentage
1980 1

1990

Source: David Carey, Jean-Claude Chouraqui, and Robert P. Hagemann, "The Future
of Capital Income Taxation in a Liberalized Financial Envoronment,"
OECD Economics Dept. Working Papers No. 126, Paris, 1993, Table 1.
* Updated to latest data in 'Tax Deform," Wall St Jour, 3 Feb. 1993, p. A14.

Shadow Open Market Committee

Figure 12 - Top Marginal Personal Tax Rates on
Capital Income (Central and lower levels of Goverment)
Selected Countries, 1990
Australia*
Austria
Belgium
Canada
Denmark
Finland
France
Germany
Greece
Ireland*
Italy fo
Japan
Netherlands
New Zealand
Norway
Portugal
Spain
Sweden
Switzerland
United Kingdom*
United States

33 eo

35
20
60
J 33
20
25

Percentage
Capital gains

Dividends

Source: David Carey, Jean-Claude Chouraqui, and Robert P. Hagemann, 'The Future
of Capital Income Taxation in a Liberalized Financial Envoronment,"
OECD Economics Dept. Working Papers No. 126, Paris, 1993, Table 2.
* Real capital gains taxed.

March 7-8.1993

Shadow Open Market Committee

U.S. FOREIGN EXCHANGE MARKET INTERVENTION IN 1992
Anna J. SCHWARTZ
National Bureau of Economic Research

Quarterly reports on Treasury and Federal Reserve foreign exchange operations ending three
months earlier than the date of publication in the Federal Reserve Bulletin are available through
October 1992 (issues of April, July, October 1992, and January 1993). These reports provide
information on purchases and sales during the quarter, if any, of which foreign currency as well as
realized net profits of losses and changes in market valuation of the preceding quarter and that of
the current quarter. The reports provide no information on the size or the composition of each
authority's portfolio.
International Financial Statistics gives end-of-month data on the combined foreign exchange
portfolio of the Federal Reserve and the Treasury. Thefigurefor December 1992 is $40.01 billion.
The corresponding year earlier figure for December was $45.93 billion. The combined foreign
exchange portfolio during the year moved within a narrow range, the peak of $45.93 billion having
been registered in December 1991, and the low point in December 1992.
INTERVENTION OPERATIONS
Why did the portfolio change as it did? One concern of the U.S. authorities was to resist
episodes of either weakness of the dollar vis-a-vis the mark or strength vis-a-vis the yen, however
futile the resistance. In January 1992, for example, U.S. monetary authorities intervened in an
operation coordinated with Japanese monetary authorities. The Federal Reserve and Treasury
Exchange Stabilization Fund shared a $50 million yen purchase equally.
The U.S. authorities also intervened on July 20 in several rounds of sales of marks totaling
$170 million, shared equally by the Federal Reserve and the ESF. The authorities repeated the
exercise in August, selling $500 million in marks on the 7th and 11th, and an additional $500 million
on the 21st and 24th.
Some of the transactions in 1992 represented operations initiated in June 1991 to reduce
D-mark and dollar foreign exchange held by the U.S. authorities and the Bundesbank, respectively.
About $1.1 billion of D-marks was sold for dollars in November and December 1991,60 percent
for the account of the Federal Reserve and 40 percent for the ESF. Another $200 million of marks

March 7-8,1993

was sold to another foreign monetary authority in November. In this reporting period, the ESF also
purchased SDRs for marks from the IMF and sold them to other foreign authorities. In a series of
transactions with the Bundesbank in the third quarterly reporting period in continuation of the June
1991 agreement, the U.S. authorities sold $6.2 billion marks for dollars.
In transactions in the quarterly period ending April 1992, the ESF repurchased $2 billion
equivalent in foreign exchange that it has warehoused with the Federal Reserve. No balances now
remain in the warehouse facility. As discussed in an earlier position paper, warehousing is a term
that refers to loans, not appropriated by Congress, from the Federal Reserve to the Treasury General
Fund as well as the ESF. The Treasury has used these funds to acquire foreign currencies. Reversing
policies of 1988-90 that gradually increased authority of the Federal Reserve to warehouse holdings
of foreign currency for the Treasury to as much as $25 billion, the two agencies agreed that the
Treasury should repay the loans, and that the Federal Reserve would not eliminate its authority to
warehouse but reduce it to $5 billion.
SWAP ARRANGEMENTS
The Federal Reserve has reciprocal currency swap arrangements with 14 central banks and
the BIS. In late January 1992 the ESF initiated a special swap facility with Panama, which repaid
in the following quarterly period the $143 million it had borrowed.
In January 1993 a wire report noted that the Federal Reserve had bought Australian dollars,
which had come under pressure as the ruling Labor party lost in election. Until the quarterly report
for the period ending January 1993 is available, neither the amount of the intervention nor on whose
account it was made can be known. Australia does not have a swap line with the Federal Reserve.
It will be interesting to learn whether the purchase was for the account of Australia or for the account
of the ESF. Intervention can be a means of exchanging political favors.
FINANCIAL RESULTS
A record of calendar year 1992 financial results of intervention will not be available until the
Federal Board and ESF publish their annual reports, about June 1993. In the meantime, the quarterly
results ending in October 1992 of net realized profits and changes in valuation profits or losses for
the Federal Reserve and the Treasury ESF can be summarized.

Shadow Open Market Committee

No realized profits or losses were reported in the second quarterly period ending April 30,
1992, but in the first, third and fourth quarterly periods net profits for the Federal Reserve totaled
$769 million, for the ESF $238 million. These results should be representative of what the full
calendar year figures will show.
The quarterly valuation results, however, are not applicable to the calendar year results. The
quarterly results, as noted above, measure the change in the market valuation of the portfolio on
the last day of the preceding and the last day of the current quarter. Losses on valuation were
reported in the second and fourth periods that did not erase positive valuation gains in thefirstand
third periods for each authority.
The quarterly results, however, cannot be used to measure the change in valuation from
December 31,1991 to December 31,1992. We can project a large loss in valuation over the year
from the knowledge that the exchange value of the dollar was low at the end of December 1991,
hence marks and yen, assuming these were the main currencies in the portfolio, would have had a
high valuation, and the substantial increase in the exchange value of the dollar at the end of December
1992, hence the portfolio, given the changes in its size and composition, would have had a lower
market valuation.
Valuation losses are unrealized losses. The authorities, however, assume the risk of realized
losses when they intervene in the foreign exchange market

Full text of Policy Statement and Position Papers : March 8, 1993

FRASER