The failure of the economy to improve significantly in recent months has prompted consideration of federal tax and spending proposals to stimulate business activity. While such consideration is certainly understandable, it is important that actions be directed to the major problems confronting the economy. In this regard, cyclical weakness in business certainly is not the only issue before us and, in any event, monetary policy has already gone to considerable lengths to address this matter. A more serious concern is an evident diminution of potential economic growth.
In the latest issue of the bank's Quarterly Review, Senior Economist David Runkle maintains that the long-run growth potential of the U.S. economy has declined. A principal basis for this conclusion is the judgment that the total number of hours worked is likely to increase more slowly in the foreseeable future than it has in the past. In turn, the slowing in hours "on the job" is related to an easing in the pace at which women and baby boomers enter the labor force and in the expansion of hours worked per person. In other words, it appears that expansion of the labor force and hours worked far exceeded trend in the 1980s and raised the economy's growth rate. This performance is unlikely to be repeated in the years ahead.
Clearly, a reduction in potential growthas implied by Runkle's analysis is not a welcome development. And this issue, rather than transitory weakness in aggregate demand, should be the focus of fiscal policy actions, it seems to me.
Policies to promote accelerated long-run growth should focus on enhancing labor productivity, either by contributing to improvement in the quality of the labor force or by increasing the quantity and quality of the capital equipment with which the labor force works. This strategy suggests policies which emphasize educationin order to improve the quality of the labor force; which strengthen private sector saving and investmentto enhance the capital stock; and which increase public sector investment in infrastructure.
Given the already oversized federal budget deficits confronting us, pursuit of these policies will require significant reorientation of government spending in order to free up funds to pay for new initiatives. Moreover, sustained commitment to progressive reductions in the deficits should be part of meaningful budget reorientation, because such a step is essential if saving is to increase and real interest rates are to decline to provide adequate stimulus to business investment.
At this stage, major reorientation of the federal budget may seem to have little practical prospect. But as we argued in last year's Annual Report, a few reforms could go a long way to at least improve the process by which budget decisions are made. Among the suggestions we offered were:
- Maintain separate operating and capital budgets.
- Require that the combined operating budget in the current and subsequent fiscal years be balanced.
- Set up rainy day funds to meet contingencies.
These proposals continue to have merit, especially in view of Runkle's conclusions about our longer-term growth prospects. In practice, they are likely to involve far more than process, for both the balanced operating budget requirement and the separation of capital and operating budgets are likely to favor government spending on infrastructure and to promote lower real interest rates, relative to the rules presently in place.