The failure of the economy to improve significantly in recent months
has prompted consideration of federal tax and spending proposals to
stimulate business activity. While such consideration is certainly understandable,
it is important that actions be directed to the major problems confronting
the economy. In this regard, cyclical weakness in business certainly
is not the only issue before us and, in any event, monetary policy has
already gone to considerable lengths to address this matter. A more
serious concern is an evident diminution of potential economic growth.
In the latest issue of the bank's Quarterly
Review, Senior Economist David Runkle maintains that
the long-run growth potential of the U.S. economy has declined.
A principal basis for this conclusion is the judgment that the total
number of hours worked is likely to increase more slowly in the
foreseeable future than it has in the past. In turn, the slowing
in hours "on the job" is related to an easing in the pace at which
women and baby boomers enter the labor force and in the expansion
of hours worked per person. In other words, it appears that expansion
of the labor force and hours worked far exceeded trend in the 1980s
and raised the economy's growth rate. This performance is unlikely
to be repeated in the years ahead.
Clearly, a reduction in potential growthas implied by Runkle's
analysis is not a welcome development. And this issue, rather
than transitory weakness in aggregate demand, should be the focus
of fiscal policy actions, it seems to me.
Policies to promote accelerated long-run growth should focus on
enhancing labor productivity, either by contributing to improvement
in the quality of the labor force or by increasing the quantity
and quality of the capital equipment with which the labor force
works. This strategy suggests policies which emphasize educationin
order to improve the quality of the labor force; which strengthen
private sector saving and investmentto enhance the capital
stock; and which increase public sector investment in infrastructure.
Given the already oversized federal budget deficits confronting us, pursuit
of these policies will require significant reorientation of government
spending in order to free up funds to pay for new initiatives. Moreover,
sustained commitment to progressive reductions in the deficits should be part
of meaningful budget reorientation, because such a step is essential if saving
is to increase and real interest rates are to decline to provide adequate
stimulus to business investment.
At this stage, major reorientation of the federal budget may seem to have
little practical prospect. But as we argued in last year's Annual Report, a few reforms could go a long way to at least improve the process by which budget decisions are made. Among the suggestions we offered were:
- Maintain separate operating and capital budgets.
- Require that the combined operating budget in the current and subsequent
fiscal years be balanced.
- Set up rainy day funds to meet contingencies.
These proposals continue to have merit, especially in view of Runkle's conclusions
about our longer-term growth prospects. In practice, they are likely
to involve far more than process, for both the balanced operating budget
requirement and the separation of capital and operating budgets are
likely to favor government spending on infrastructure and to promote
lower real interest rates, relative to the rules presently in place.