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Spring 2002 CalBusiness  
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Lesson 4

Having briefly extolled (good) rules, we hasten to add that the Fabulous Decade seems also to have resurrected an idea that most economists thought had died in the 1970s. Our Lesson 4 is that it now appears that fine-tuning is at least possible. If not, we would like to know what Alan Greenspan has been up to since 1992. Indeed, we nominate Greenspan as the greatest fine-tuner in history. Once again, however, a caution is in order: to declare that something is possible is not to assert that it can be done easily or regularly. Successful fine-tuning requires a blend of skill and luck that may well be rare. (We would also argue, perhaps controversially, that greater transparency helps make fine tuning work. Since 1996, the markets have developed a better and better understanding of what the Fed was up to. In consequence, it was often said that long-term interest rates were "doing the Fed's work for it.") Alan Greenspan has had both, in abundance; others have had neither. And some people feel that even Greenspan's luck may have run out in the Fed's 1999-2000 tightening cycle, which went too far, according to some critics.

Furthermore, nothing in the history of the 1990s makes us at all optimistic about the feasibility of fiscal fine-tuning - the sort of thing that Walter Heller (1966) preached and tried to practice back in the 1960s. At least in the United States, the federal budget-making process looks extremely cumbersome, highly politicized, and not terribly responsive to economic logic. It is not for naught that Congress has shackled itself with rules. Among economists, there is an evolving tacit consensus that demand management should be left to monetary policy while fiscal policy is used as a long-run allocative tool - although the Bush administration is fighting this consensus at present as it tries to sell a large income tax cut on stabilization-policy grounds. (This is slightly odd, since the Bush tax proposal long predates the economic slowdown and was not designed to alleviate it. For example, the amount of tax cutting in fiscal years 2001 and 2002 is small.) Without elevating this principle to the status of a commandment, for we must allow for exceptions, we agree that monetary, not fiscal, policy should carry most of the stabilization burden - at least in countries that have independent and capable central banks.

Main Story / Lesson 1 / Lesson 2 / Lesson 3 / Lesson 4 / Lesson 5

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