Headlines are applauding the Federal Reserve's drop in interest rates and the White House/congressional drive to send checks to most American families. But what's the long-term cost of short-term happiness?
Price stability is a necessary condition for any economy's sustainable, healthy, long-term growth. While volatility is natural on Wall Street, sharp and unpredictable price changes on Main Street lead to inefficiencies.
Inefficient investments waste scarce resources. Waste translates into lowering (or slowing down) the growth of our living standards. In extreme cases, such as the post-WWI hyperinflation in Germany, the national currency might collapse. When this happens, the whole economy goes down the drain.
Maintaining price stability should be a priority for our leaders in Washington. Does such a long-term focus mean that they should ignore immediate pains? Yes. Most of the time.
After Sept. 11, 2001, dramatic action was important. When the Fed cut interest rates last month by more than it did after 9/11, some economists went pale, grabbed the remote, and raced through news channels. No falling planes. No natural disasters. Without such an emergency justification, Washington now threatens price stability.
This year already the Fed has injected the banks with tens of billions of dollars. By springtime, Congress is expected to inject hundreds of billions more into the pockets of the American consumer. Free money? To quote John Stossel on similar government schemes: "Give me a break!" These Washington actions do not help long-term price stability. And, from a psychological point of view, they send all the wrong signals to the public.
The message to the public in this interest-rate drop, which lowers the cost of borrowing, is clear: Better days for those deep in debt because they abused their credit cards, bought homes and cars they could not afford, and speculated on the stock market and in real estate.
But short-term economic relief brings with it the threat of unpredictable inflation. The vicious cycle of recession-inflation-recession that characterized the 1960s and 1970s could be back.
In short, Washington is wishing upon a star that consumers will keep buying stuff on credit while businesses are tempted by banks with cheaper loans to hire more workers to expand the production of stuff. If we go soon through an unremarkable recession, the Washington economists will claim credit for preventing a depression. If no such trouble comes in 2008, they will be hailed as heroes-at the expense of the U.S. dollar, which will continue to decline in value on the world markets.
Non-economists should understand that directing the economy is like a mostly blind motorist driving a tank through an antique porcelain store-and the tank has a mind of its own. The driver can't see where he's going and doesn't know where he is. He has no map, only partial information about where he was a few months ago. He knows that if he steers left and the tank chooses to obey, it will take a few months to start turning that way-and by that time, he might want to steer right.
Unless the government is hiding from us information of an asteroid approaching planet Earth or of an unfriendly rogue army acquiring WMDs, the last thing we need is a startling yank on the steering wheel by our mostly blind driver.
-Alex Tokarev is an economics professor at The King's College, New York