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Saturday, December 03, 2005

Dallas Fed President Fisher on How Globalization Affects Monetary and Fiscal Policy

The following four posts contain summaries of four speeches by members of the Federal Reserve, two by Alan Greenspan (here and here) one by Janet Yellen of the San Francisco Fed, and one by Richard Fisher of the Dallas Fed in this post. There were also two speeches yesterday, one by William Poole of the St. Louis Fed (part 1, part 2), and one by Susan Bies from the Board of Governors, so there has been a small flurry of FedSpeak. If you are interested in the future course of monetary policy, Janet Yellen's speech is the most informative.

Here's Fisher's speech on how monetary and fiscal policy are affected by globalization. While Greenspan also talked about fiscal policy today, Fisher's remarks are more complete, more hard-hitting, and more connected to monetary policy. For example, he actually explains how bad fiscal policy can create bad monetary policy through pressures to monetize the debt, and how debt monetization is affected by globalization. I don't agree with everything he says, but I'm starting to like Fisher's willingness to say what he believes needs to be said:

Globalization and Government Policy, by Richard W. Fisher. Dallas Fed President: ...I wish George Shultz could be here. I’m sure many of you know him... He is a distinguished economist and public servant, who inside and outside government has been an advocate for fiscal sanity for decades. Shultz is now at Stanford University’s Hoover Institution. I spoke with him a few weeks ago and, sure enough, our conversation turned to one of his biggest concerns: our burgeoning structural fiscal deficits. He told me a story I want to share with you. When he was President Nixon’s budget director, Shultz became increasingly worried about the inability of Congress to cut spending. Sitting in his office at 2 in the morning, he turned to his venerable aide, Sam Cohen, and asked, “Sam, is there really any difference between Republicans and Democrats when it comes to spending?” After giving it some thought, Cohen replied, “They both spend money. The only difference is that Democrats enjoy it more.” It is no longer clear who enjoys it more, but it is crystal clear we need to have a little less enjoyment and a lot more fiscal rectitude. ... I am ... deeply concerned about the magnitude of deficits projected 20, 30 and 40 years into the future. Left unchecked, they will become a grave danger to our prosperity and run the risk of seriously undermining the progress we have made in taming inflation. That said, I believe the discussion of America’s fiscal deficits is not complete unless we take into account the forces of globalization...

Globalization describes the economic reality of our times. ... U.S. business leaders have come to grips with the inevitability of global competition. Now, our policymakers must prove they can do the same. I think monetary authorities around the world have gotten the message. They have achieved a new discipline, thanks in part to the competition created by globalization. Open financial markets allow investors to seek countries with stable money and shun those places where the value of their capital will be eroded. ... Has globalization brought a similar disciplining force to fiscal policy? It is hard for me to stand here today ... and tell you we are seeing better fiscal policies. Yet, I believe that globalization is having a beneficial impact on fiscal decisionmaking ... Let me first turn to the discipline imposed on fiscal policy by global forces.

Take taxes. In a world where capital moves across borders more freely than ever, globalization heightens tax competition among nations... Indeed, we are seeing the average tax rate come down in the world’s most open economies as nations compete for productive resources. ... One would think that globalization would lead to similar discipline on the spending side. ... But the deficit-reducing pressures anticipated by theory have yet to arrive in reality. ... Why is this? I will offer one suggestion... Other potential destinations for significant investment are actually doing worse than we are in terms of fiscal policy. ... In terms of investors looking to allocate their capital, and the impact they have on the price of money, you cannot think of U.S. fiscal policies in strict isolation from what is happening in other countries. Our long-term fiscal prospects may be daunting, but we do not suffer from the economic sclerosis that afflicts the Japanese and the major European powers.

Looking longer term—to the structural problems of Social Security and health care programs ... Syndicated columnist Scott Burns and Boston University Professor Laurence Kotlikoff describe the demographic challenge in catchy terms in their thought-provoking book, The Coming Generational Storm. They divide the nations of the world into four quadrants defined by two dimensions—life expectancy and birthrate. One quadrant is occupied by the major European economies, Japan and China, all of which share the characteristic of a long life expectancy and low birthrate. This group they label the “Decrepit Quarter.” Another, defined by low birthrate and short life expectancy, is morosely labeled “Postmodern Malthusian Hell.” It is occupied almost exclusively by Russia and other former Soviet states. The United States inhabits the quadrant Burns and Kotlikoff call the “Panglossian Balance.” In their view, we teeter on “the tattered edge of Panglossian balance,” with a population replacement rate that is dangerously close to being insufficient but still better than Europe’s, Japan’s and China’s and free of Russia’s unique pathology. From an investor’s viewpoint, one might reasonably assume that Panglossian Balance trumps the Decrepit Quarter and Postmodern Malthusian Hell—to say nothing of the fourth quadrant, occupied by high-birthrate, low life-expectancy Africa and labeled “Traditional Malthusian Hell.” ...

Compared with other nations, we look fairly handsome, or at least less ugly. That said, being better than the worst is cold comfort. ... It always comes back to globalization. A world of porous borders, for example, increases the ability of younger citizens to escape the taxes foisted upon them by the elderly. The young aren’t handcuffed to the old—at wage-earner-to-pensioner ratios of 10 to 1, 3 to 1, or whatever the demographic profile might be. Why should the productive, mobile youth of the 21st century, cyberpowered from birth and at home in an interconnected world, stay and subject themselves to high Social Security taxes when they can move somewhere else and keep much more of their pay? Globalization makes it harder to sustain a Social Security system based upon intergenerational transfers. ... If our fiscal authorities were to take this and other real world verities into account, it might just encourage better policies. And putting our fiscal house in order before our competitors do would further enhance our edge as an investment destination, securing the future of successive generations of Americans.

At face value, fiscal policy may not seem a concern for the Federal Reserve. Taxing and spending, after all, are not the Fed’s business. Congress holds the power of the purse. But the Fed cannot be an indifferent bystander to the overall thrust of fiscal policy. The reason is straightforward: Bad fiscal policy creates pressure for bad monetary policy. When fiscal policy gets out of whack, monetary authorities face pressures to monetize the debt, a cardinal sin in my mind. I do not believe the Fed or any other responsible central bank has total leeway to monetize deficits in a globalized world anyway. ... In a closed economy, the Federal Reserve might face political pressure to keep interest rates from rising, with an eye toward accommodating fiscal stimulus. ... Doing so would fuel inflation. In an open economy, however, the situation is different. When capital is free to move at the click of a computer mouse ... we cannot accommodate political pressures even if we were so disposed ... because of the added risk of capital flight to destinations where ... purchasing power ... is better preserved. It is the duty of the Fed to refrain from the slightest temptation to monetize deficits or embrace any other inflationary policy. ...

I think a city ordinance requires that all speakers taking a podium in Philadelphia quote Benjamin Franklin. This is easy for me because I always carry a few words from Franklin as a reminder of my obligation as an inflation fighter. In 1748, when we were a society of farmers and the crown was the colonies’ currency, Franklin said, “He that kills a breeding sow destroys all her offspring to the thousandth generation. He that murders a crown”—a dollar—“destroys all that it might have produced.” This was true in the agrarian world of Ben Franklin, and it holds as well in the cyber, nano, bio interconnected world of Ben Bernanke... Coddling inflation by monetizing deficits is not an option in a globalized world. It would erode our currency’s value and undermine our economy’s potential to grow and create jobs. ...

    Posted by on Saturday, December 3, 2005 at 01:11 AM in Budget Deficit, Economics, Fed Speeches, International Finance, International Trade, Monetary Policy | Permalink  TrackBack (0)  Comments (0)


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