Monday, December 7, 2015

When Policies Collide

C'mon kids, play nice

In his column in the Financial Times, Harvard professor and former Treasury secretary Larry Summers discusses the economic tools available to the Federal Reserve, concluding that future economic growth "demands urgent attention from fiscal as well as monetary policymakers."

We often ascribe success and failure to one person or group, as in "the President should have" done this or "if Congress had only" done that. But it's complicated, and interdependent.

Monetary policy in the United States – as prescribed by Congress – has a "dual mandate": stable prices and full employment. The Fed has a number of tools at its disposal to comply but full employment requires other contributors to create jobs in a low-interest-rate environment. The idea is that low interest rates will encourage the private and public sectors to borrow at low rates thereby pulling underutilized labor and capital assets into productive economic activity.

But the Fed's "accommodative" money stance doesn't work unless the other participants truly participate. Fiscal policy requires government to spend when the economy is slack and pay off debt when the economy is humming. Here, Congress holds the baton; the President can only suggest and agree. But as we've seen, legislators are generous and thrifty at the wrong times, gorging when tax revenues are high and starving when revenue dries up. And private industry, prone to risk aversion, will sit on the sideline until politics are certain and tax considerations favorable (or at least not punitive).

Tax policy is also the venue for Congress. But whereas the tax code should be efficient and clear-sighted it is, instead, clumsy and distorting. No one really knows their effective tax rate, and Congress has lowered rates when the economy is hot and raised rates when it's cool. (For an example of the latter, look no further than the rise in Social Security tax rate increase in 2013.)

Regulatory policy is in the hands of the President and his administration's departments, and is most frequently cited as restraining economic activity. But it is also put in place to deter economic externalities, byproducts that are harmful to those not engaged in economic production. I prefer using taxes to dissuade externalities, but to some lawmakers the word "tax" is more toxic than pollution.

Competition policy is not usually broken out as a separate realm, but given that some regulatory legislation and policies are anti-competitive (think Jones Act, import restrictions, occupational licensing), I believe it's important to address competition separately. Anti-competitive behavior – whether codified by legislators succumbing to special interests or private interests wielding monopoly power – works against economic growth and toward skewed outcomes.

With an economy as complex and dynamic as ours, no one policy can act in isolation. Failure and obstruction in one arena can hobble the others.

And that's what troubling about the current political environment: each participant wants to claim victory yet none wants to shoulder the responsibility. The Fed has come closest, showing, as Mr. Summers asserts, that it's done as much as it can – even in the face of "strong headwinds" from fiscal inaction.

I guess cooperation among economic policy makers is tantamount to political capitulation for lawmakers bent solely on winning. It's a shame they see it that way, because we all lose as a result.