We don’t need an economic boom, but that’s what we may be getting. Since the 2016 election, the stock market is up roughly 24%, reports Wilshire Associates. The price of the cybercurrency bitcoin soared more than 1,000% before retreating. The unemployment rate of 4.1% is the lowest since 2000. The economy’s growth has exceeded 3% for the past two quarters.
Anyone familiar with the post-World War II economy is bound to feel ambivalent about these dazzling developments. On the one hand, after so many years of disappointment following the Great Recession of 2007-09, it’s nice to see the economy outperforming. Since the low point in late 2009, nonfarm jobs have increased by 17 million. On the other hand, extended booms give rise to long busts that have been hugely destructive in human terms — meaning higher unemployment and lower incomes.
Since World War II, there have been two instances of these grand boom-bust cycles. The 106-month expansion in the 1960s was followed by more than a decade of economic turmoil: double-digit inflation, four recessions (unemployment peaked at 10.8% in late 1982) and a stagnant stock market corrected for inflation. The second grand cycle started with the tech boom of the 1990s that lasted exactly a decade. It led to the economic carnage of the 2008 financial crisis and Great Recession.
The ultimate source of these boom-bust episodes is human nature. Although prosperity is a good thing, long stretches of good times can become self-destructive. People — consumers, business owners and managers, bankers, investors, entrepreneurs — become sloppy, overconfident and complacent. They become increasingly vulnerable to economic setbacks, but their careless behavior continues because it is crowd-driven.
This history cautions prudence. We don’t know whether the economic recovery that began in mid-2009 will end in some sort of crack-up. But we should minimize the odds of this happening by avoiding policies that overstimulate the economy when it doesn’t need more “stimulus.”
In the present context, there are two implications. First, the Federal Reserve should continue raising short-term interest rates, which are still low. And second, the Republican tax legislation now being considered by Congress should not increase budget deficits by a penny. The various tax proposals are estimated to add from $1 trillion to $1.5 trillion to deficits over a decade, depending on how the calculations are done.
Lowering tax rates is good; borrowing to do so, as opposed to closing other tax breaks, is bad. What’s often overlooked is that even before the Republican tax proposals, projected budget deficits were sizable. The Congressional Budget Office estimates them at $10 trillion cumulatively from fiscal 2018 to 2027.
XMany mainstream economists have convinced themselves that the tax proposals won’t stimulate the economy or threaten the recovery. Here’s the conclusion of a study from Moody’s Analytics:
“Neither the House or Senate (tax) plans would meaningfully improve economic growth. … Growth would be stronger initially, since the deficit-financed tax cuts are a fiscal stimulus. But given that the economy is operating at full employment, stronger inflation and higher interest rates will result. The economic benefit of the lower tax rates on business investment is washed out by the higher interest rates.”
Maybe. But in practice, this view may be too sanguine. Suppose the strong demand of a boom economy causes inflation to exceed expectations — say 4% instead of 2%. The increase could set off a destructive chain reaction. Higher inflation begets higher interest rates. (The Fed raises short-term rates; market pressures push up long-term rates on bonds and mortgages.) Higher interest rates darken the economic outlook, causing stocks to crash and confidence to slump.
The truth is that we don’t fully understand the effects of budget deficits on the business cycle. On the other hand, we better understand history, and history suggests that the bigger the boom, the bigger the subsequent bust. A patient economy may ultimately be more rewarding and sustainable than its more spectacular counterpart.
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