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ON THE SPOT From Analyst to Professor—Macroeconomist Trades Federal Reserve for Oberlin June 17, 2004
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Danforth-Lewis
Professor of Economics Kenneth Kuttner answers five pressing questions
about the economy, including the impact of the war in Iraq and the
effect of rising oil prices. What
do you think of the Bush tax cuts?From a macroeconomic perspective, the Bush tax cuts were actually well timed; they stimulated spending when the economy was struggling to recover from the 2001 recession. The cuts did have unfortunate side effects, however; they made the tax system much more complex and arguably less equitable. Now that the economic recovery seems well under way, that stimulus is no longer needed. Some people would argue for rolling back many of those tax cuts and restoring some semblance of fiscal discipline.  What
impact will the war in Iraq have on the economy?There are two main effects. One is on labor supply: calling up reserves and sending them overseas obviously reduces the number of people available for gainful employment here at home. Relative to the overall size of the labor force, however, this impact is pretty small. A more subtle, but potentially much larger impact will be the burden of financing the war's cost ($125 billion, so far). For now, the government is simply borrowing the funds it needs for the war. But eventually, the money will have to come from somewhere: either taxes will have to be increased, or other expenditures will have to be cut. The war's ultimate economic impact will therefore depend on these future budgetary decisions, the effects of which will be felt for years to come.  Will
the Fed continue to be the driving force in the country's economy?Yes, the Fed will continue to be a key player in U.S. economic policy–although "driving force" might not be the right way to describe its role. The real force propelling our economy is growth in productivity, which ultimately depends on the education, ingenuity, and energy of the country's workforce. Monetary policy should be as unobtrusive as possible, keeping the financial system functioning smoothly and intervening only to the extent necessary to dampen undesirable fluctuations in economic activity.  What
effect will rising oil prices have on the economy?The current oil price of around $40 per barrel is high–but not that high, once you adjust for the upward trend in the overall price level. But if the price continues to go up, and stays up, it will create more serious problems. One would be the direct impact on inflation. Another would be to reduce the productivity of capital and labor. We could then find ourselves facing the unattractive combination of rising inflation and slow growth, which would present a very difficult policy dilemma for Fed policymakers.  When
do you think Alan Greenspan will retire, and who would make an apt
replacement?I have no clue as to when Greenspan will retire. What's certain is that he will be a tough act to follow–it's hard to think of anyone else bringing to the table the same intuitive feel for economic principles, encyclopedic familiarity with the data, and political savvy. But thanks to the economic expertise and institutional credibility built up over the years, good policy in the future will not require a major advance in cloning technology. It will be essential for the Fed to explain that its objectives–and its approach to meeting those objectives–will remain unchanged under any successor. This may require the Fed to become somewhat more explicit in articulating its objectives–which might not be such a bad thing for its own sake. |
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