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Improving the Prospects for Prosperity

Jerry L. Jordan
President and Chief Executive Officer
Federal Reserve Bank of Cleveland

presented to

The Cleveland Rotary Club


Thursday, January 22,1998
University Club
Cleveland, Ohio

Thank you. I’m pleased to have this opportunity to address the Rotary
My comments today are about “Improving the Prospects for Prosperity."
My focus will be the longer-term —specifically, what we have learned about
economic policies that foster prosperity and about economic policies that hamper
• Time: (perspective of audience different than speaker)
Economist/North Dakota
No Forecasts/Statistics:
• I learned some time ago that there are 3 kinds of central bankers—
those who are good with numbers — and those who aren’t.
I used to think —
joke —letter to returning directors.
In about 15 years, my two new granddaughters will be sitting in a classroom
somewhere listening to a teacher trying to explain the 20th century. Of course,
they’ll be way ahead of the other kids because I’ve already explained it to them.
Much of this century involved a contest of ideas about the relationship
between the individual and the state:
• in political affairs, a contest between democracy on one hand and
various forms of dictatorship on the other;

in economic affairs, a contest between markets and socialism.

In this final decade of the century, the contest is over; democracy and
markets have proven their superiority, and will be the dominant political and
economic regimes of the 21st century.

About seven years ago, the then Finance Minister of newly liberated
Czechoslovakia said that they were going to create a market economy without
adjectives. I’m sure people had at least two thoughts about that phrase.

One was that they did not know what it meant.


The second was that they did not think it would happen.

The events of this last decade of the century suggest that not only the Czech
Republic, but also many other places, will have in the 21st century a market
economy without adjectives.

A Contest Is Won
It’s a little over eight years since the dismantling of the Berlin Wall
(November 9, 1989), symbolizing the failure of communist central planning and
the demise of the Soviet Empire.
Imagine the reaction of students just a few years from now, in the early
years of the next century, as high school teachers recite Winston Churchill’s 1946
observation that an Iron Curtain had descended through the middle of Europe.
On the other side of curtain, conditions were bleak because people were
denied many rights:

• private property was illegal; people could not own apartments,
shops, or farms; [DUMB]
• individuals could not buy products made in Western countries;
• workers could not change jobs or go into business;
• people could not simply decide to move from one city to another;
they were even forbidden from traveling outside the Soviet Union;

• people could not receive radio or TV news programs, newspapers,
magazines, movies, or any other information from the West.
Imagine the students’ surprise in learning that a major city in the middle of
Berlin— a wall running through the middle of it for more than 25
years that prevented people on one side from shopping, working, or even visiting
friends and relatives on the other side. The reaction of the 21st century teenagers
will undoubtedly be that such a regime was obviously dumb and unworkable.
The crumbling of the Berlin Wall will be treated in history as a major
political event, but equally intriguing are the underlying forces at work that
produced that political event.
In his book, Turmoil and Triumph, former U. S. Secretary of State George
Schultz described his first meeting with Mikhail Gorbachev.
Schultz explained to Gorbachev that the accelerating pace of technological
change in information and communications was difficult for even the United
States to keep up with, compared with places like Taiwan, Korea, Singapore, and
Hong Kong. Old Western Europe was falling behind the Asian tigers, and for the
socialist/communist, top-down, command-and-control economies, the situation
was hopeless.
Gorbachev might have already recognized the power of such forces, and not
long after taking power, he launched his Glasnost and Perestroika reforms in an
ultimately futile attempt to put some flexibility into the Soviet economy.

After four decades of Soviet isolation, it finally seemed as though the
political leaders one day simply said, “never mind —it was all a big mistake,” and
the Iron Curtain suddenly collapsed —symbolized by the physical destruction of
the Berlin Wall.
The intrusions of the state into the economy were most extreme in the
Soviet Union, but government suppression of personal and economic liberties had
occurred almost everywhere.
The 1930s was a watershed decade around the world. In the midst of a
worldwide economic depression, the response of most countries was to greatly
increase government intrusion into such decisions as what could be produced and
where, how much things would cost, how much could be paid for labor, what
interest rates could be paid or received, and even how much profit could be
In U. S. monetary affairs for example,

• for more than 40 years, it was illegal for Americans to own gold;
(I’ve tried to explain)
• for 50 years, the government set a maximum interest rate that
people were allowed to earn on their savings;
• arbitrary regulations made it uneconomical for banks to issue
traveler’s checks;
• some institutions could make mortgage loans, but not car loans;

• some institutions offered savings accounts, but not checking
accounts -- withdrawals were made only in currency, or in a check
that you then deposited into your checking account in another
institution so you could write a check to pay for something;
• across a state line, you could make a withdrawal from your
account, but you could not make a deposit.
To each of these prohibitions, my granddaughters will say, “that was dumb.”
But that is all in the past. For the future, allow me to suggest some specific
rules for fiscal policy and monetary policy that will be helpful rather than harmful.
Clearly, political institutions encompass organizations and rules that affect
• If rules improve markets—they enhance prosperity.
• If they interfere with markets—they hinder prosperity.
As we are trying to teach the newly liberated countries of the former Soviet
Union, some government rules are essential to the functioning of a market
economy; government provides the legal infrastructure essential to capitalism.
Examples of prosperity-enhancing rules are:

• Property rights
• Contract enforcement by an impartial judicial system
• Freedom of speech and press
• Standards for weights and measures; and generally accepted
accounting principles

Examples of prosperity-hindering rules are:
• Wage and price controls
• Interest rate controls
• Credit allocation and industrial policy
• Controls on foreign-exchange transactions and capital flows
• Trade restrictions, whether in the form of tariffs, quotas, or other
barriers to free exchange of goods and services.
Unfortunately, policymakers often try to:
• Help the already prosperous by restricting competition.
• Help the less prosperous through wealth redistribution rather than
wealth creation.
• Gain political support through policies that help in the short run,
but hurt in the long run.
• Solve problems by imposing more rules.
The experience of the 20th century shows that successful policies are those
that enhance the effectiveness of markets. In response to that experience, three
broad trends are sweeping the world:

• deregulation
• denationalization/privatization
• tax reform/reduction [relative size of government sector trending

Economic Policies of Government
Our experience of the past few decades has taught us specific ways that
monetary and fiscal policies can improve the operation of markets and thereby
enhance prosperity.
A good place to start is with clear rules that limit the use of discretion by
monetary and fiscal policymakers. Activist, discretionary, stop-and-go monetary
and fiscal policies of the past have done more harm than good.
• Under clear rules, households and businesses would face less
uncertainty and make better decisions about consumption, saving,
investment, and production. Also, fewer short-sighted, politicallymotivated policies would be imposed.

A Monetary Policy Regime
Monetary policy should pursue sound money. It should seek to create
conditions where businesses and households can make decisions with confidence
that the purchasing power of the currency will be about the same in the future as in
the present.
Sound money enhances prosperity in several ways:

• It avoids capricious redistributions of wealth.
• It ensures that resources won't be wasted in efforts to avoid being
on the losing side of such redistributions.
• It encourages saving and investment (inflation interacts with the
tax system to discourage saving and investment).
• It facilitates planning of production, consumption, and saving.

• In an inflation-prone regime, business leaders say “we are losing
(or not making enough) money, so we’ll have to raise our prices.”
In a stable-money environment, they say, “we’ll have to become
more efficient and productive —and cut our costs.”
The only sustainable pro-growth, pro-employment, policy is stable money.
Throughout the world, wherever governments have mandated that their
central banks maintain a sound currency, the mandate has increased the credibility
of the commitment.
• Greater credibility facilitates maintaining sound money because it
causes buyers and sellers, employees and employers, to base their
price and wage decisions on the expectation that the dollar’s
purchasing power will stay constant.
Wherever governments have mandated that monetary authorities have no
objectives regarding short-run growth of output, employment, or other real
magnitudes, sound money has helped achieve all of these objectives in the long
In contrast, attempting to use monetary policy to pursue output and
employment goals directly in the short run impedes their achievement in the long

A Fiscal Policy Regime
Our experience has also taught us some things about fiscal policy.
Governments are learning that they cannot manipulate a budget deficit for
countercyclical purposes.
• There is no balanced-budget multiplier.
• There is no deficit-spending multiplier. Few people believe deficit
spending has any lasting stimulative effect on economic activity:
Any beneficial effect is transitory and quickly reversed.
• Imagine an economics teacher in the 21st century explaining to
incredulous students that back in the 20th century, conventional
textbooks taught that increasing the relative size of the
government sector was stimulative to the economy, and that
deficit financing was even more stimulative!
Tax and spending proposals are now evaluated for their effects on
incentives and resource allocation.
• They can affect incentives to work, save, and invest.
• They can shift resources between consumption and investment.
In these ways, government spending and taxing can change the long-run growth
path of output and thus affect our standards of living over time.
1980s: Chairman of the U.S. Senate Finance Committee:

• encourage/discourage —sin tax (alcohol & tobacco).
• Working, saving, investing, inventing, innovating, or owning and
using productive resources —(anti-social).

Politicians must learn to accept that:
• To tax something is to discourage it.
• The primary incidence of taxation should fall on consumed
• A tax burden on individuals can't be avoided by levying taxes on
businesses. Only individuals ultimately pay taxes.
• Tax policies should be evaluated by considering whether
individuals bear the tax in their roles as workers, consumers, or
Policymakers and voters should not act on the myth that the burden of
taxation is determined by the current level of tax revenues. The true tax burden is
determined by the amount of government spending. Ultimately, all government
expenditures must be financed by:
1. present or future explicit taxation;
2. government money creation —inflation; or
3. unilateral transfers or gifts from foreign sources.
Actions that reduce current tax revenue without decreasing either present or
future government expenditures, do not constitute a reduction in actual tax
Conversely, decisions that reduce either the current level or the growth of
government expenditures, from what they otherwise would have been, are a
genuine reduction in tax burdens, even if explicit tax revenue is not altered.

Deficit spending should not be thought of as an alternative to taxation.
• It is a method of deferring explicit taxation, or
• It can encourage taxing through inflation.
In that sense, inflationary monetary policy can be viewed as an instrument of

I’d like to leave you with a few general observations:
• Government does not cause growth to occur.
• Government does not create wealth.
• Government intrusions that interfere with the functioning of
markets lower our standards of living.
• Often, government regulations have reduced the natural discipline
and regulation of market forces.
• Rules that enhance the functioning of markets are much more
essential to economic prosperity than are politically created and
controlled organizations, no matter how well-intentioned their
Back in the 1920s, the Italian dictator, Benito Mussolini:
19th Century: Civil Liberties
20th Century: State
I hope and expect that:

21st Century: Markets