The Region

Economics and Policy

Top of the Ninth

Gary H. Stern - President, 1985-2009

Published December 1, 2006  |  December 2006 issue

Editor's note: This column is based on remarks presented on Oct. 17, 2006, at the close of the Supply, Demand & Deadlines Workshop, in Chantilly, Va. Stern's talk followed presentations by David Card of the University of California, Berkeley, Matthew Slaughter of the President's Council of Economic Advisers and V.V. Chari of the University of Minnesota and the Minneapolis Fed.

I've been wondering what I could add to all of this because I think we've had some really first-class presentations and lots of excellent discussion, and I want to thank all of the participants at this conference. At least from my perspective, it's turned out to be stimulating and fascinating. I certainly have enjoyed it and gotten value from it.

Obviously, I'm not going to try to review everything that David Card and Matt Slaughter and Chari had to say, tempting though that might be, but let me just comment on a few things selectively, a few observations that I thought were particularly significant or intriguing.

Careful research and market flexibility

As you recall, David Card got us started, and the overriding topic was immigration. A couple of things struck me about David's presentation that I thought were particularly important. One is, I think that his work is a great example of how complex careful economic research is, and it illustrates why you want to do careful research and why you don't want to make too many generalizations about your conclusions or go with what I might call "public myths."

I took his analysis to indicate that it's very difficult to find evidence that immigration has had a substantial effect on wages, despite a serious effort on his part to discern whatever effect might exist. If you take that conclusion as approximately correct and say, well, even if it has an empirical effect, it's pretty small, then the interesting question is, Why isn't it larger? Because as many people observed, you would think that if you have an increase in supply, that would have a significant effect on price, other things equal. What David talked about—and it's a theme that I try to emphasize in my remarks frequently when I'm out speaking to the public, albeit in a somewhat different context—is how decision makers in businesses have some choices they can make about technologies, in particular, if they find themselves with a large pool of unskilled labor available to them.

It's also an important point that capital is mobile within the United States—pretty mobile globally too, but certainly within the United States—and mobile capital is able to take advantage as well of large pools of unskilled labor. And I think these examples of flexibility turn out to be very important in understanding and providing the intuition for Card's results.

I think flexibility is a hallmark of the U.S. economy, in fact. It's something we all know about, but we may underestimate it from time to time. I think we forget how good the U.S. economy really is, without any help from policymakers and so forth, at reallocating resources when there are incentives to do so.

The importance of good policy

Let me move on to Matt Slaughter. His comments, as you know, were off the record, so I will touch on them quite indirectly. Matt talked about the current account deficit and reviewed some of the implications of that. I'd like to spend a moment addressing a concern that others have raised: the possibility or probability that this is all going to end very badly in the sense that China and some of our other large creditors might decide some day that they just don't want to hold dollar-denominated assets, at least not at the current rates of return they're getting. So they might start to dump assets, with implications for exchange rates and interest rates and the economic performance of the United States and so forth.

Clearly that's a legitimate set of concerns or questions, and I think that part of the fundamental answer to that is—this may not be sufficient, but it's certainly necessary—we have to continue to follow sound economic policies in the United States. That's going to be key. Because you can imagine what the opposite of sound policies may be. If you're worried about people losing confidence and being unwilling to hold U.S. dollar-denominated assets at current interest rates or current rates of return, there's nothing like poor policy to undermine some of that confidence.

In particular, I think that one risk is the possible rise in protectionism in the United States. That would be a tip-off that we were moving away from relatively good to relatively poor policy, and I would suspect that that would not be read well in the global marketplace.

Sooner, not later

Something else that came up—and Chari mentioned it too—is the, I'll put it this way, prospective collision between entitlement programs and the underlying demographics on the one hand, and our current tax system on the other. I think there is no question that if we don't change entitlement programs and we don't change taxes, we will face an amazing deficit problem somewhere out in the future. There are really only two choices to address that sort of thing. You have to change either tax policies or spending policies; that's all there is. I'm not going to weigh in on what might be the best mix to address that problem; I don't know the answer to that. But I would observe that we're better off starting to address that issue sooner rather than later.

Why? Well, let's suppose that part of the solution turns out to be that we want to cut entitlement programs—Medicare, Social Security—relative to current law. That isn't going to affect me. I'm going to be retired and long gone before any of that hits. But it's different for younger people who are working today and people who are going to be joining the workforce shortly, so people who are in their 20s, 30s, 40s. If we're going to change the rules, we want to let them know as soon as possible so they can start to change their behavior as soon as possible. That means if they want to save more for the future because they're going to be picking up more of their own medical expenses or more of their retirement expenses and so on, we want to let them know as soon as possible. It's easy to stand up here as an economist or a policymaker at the Federal Reserve and talk about that. We all know that it's the so-called third rail of politics, and we have not been willing to address these issues.

Taxes and targets

Finally, Chari provided his own summary, and you just heard from him, so I might just say a couple of words about that discussion. One of the fundamental points was that if we're interested in minimizing distortions to the work-leisure decision and the spending-saving decision, then something like a progressive consumption tax is worthy of serious consideration. It seems to me that—Chari is maybe a little more optimistic than I—it seems to me we're a long way from that. But the economic merits of it, I think, are pretty compelling.

As far as inflation targeting is concerned, obviously, that is a hot topic today. Many of us have opined on that in one form or another. The Federal Open Market Committee, as part of our broad review of communication strategy, is currently looking at it as well, and I think one of the values of the debate and consideration of the issue is to think about institutionalizing and formalizing in many ways what the Open Market Committee has largely been doing.

And I do think it's worth considering, speaking only for myself, as usual, but I think it's worth considering a more formal, rule-based approach to policy because, after all, it's questionable whether we want policy based on the wisdom of one or even a small handful of individuals. Even if you believe that today's Open Market Committee is great and is going to get it right, there will be a new Committee in place some day, and while you can't bind future Committees—they can always change the rules, they have the right to do that—you can raise the bar and make it more difficult for them to change the rules, if you want to.

So I think with that I'll stop. As I said earlier, from my perspective this has been a valuable conference. I hope it has been from your perspective as well. Thank you for joining us.

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