Classical Exuberance, Bursting Keynesian Bubbles

Excerpt from The Green Book.

In my opinion, this is not the “normal operation of the business cycle,” nor the aftermath of a “burst bubble.” Asset values have collapsed across the board, especially in the high-tech sector, not because they were unreasonably high, though some were, but rather because deflationary monetary policy slammed the economy into lower gear, made promising business plans unachievable and otherwise prudent debt levels unmanageable.

Contrary to wishful thinking among many forecasters and some government officials, the economy was not on the mend before September 11. And, contrary to conventional wisdom, the main obstacle to economic revival is not a collapse in consumer confidence brought about by the attack. I also, with all due respect, disagree with Fed Chairman Alan Greenspan and former Treasury Secretary Robert Rubin that the risk of rising long-term interest rates poses a serious constraint on how much tax rates can be reduced to restore incentives to work, save and invest. In our $10 trillion economy and global capital market with daily transactions on the order of $2 trillion in which long-term interest rates are set, even a $200 billion or $300 billion annual reduction in revenues would have no discernableeffect on interest rates.

In my opinion, three fundamental changes in policy are required before we see a return to prosperity:

– Congress and the President must insist that the Fed adopt new operating procedures that will ensure an end to deflationary monetary policy.

– Further, tax code reform must be enacted. Tax rates must be cut broadly and deeply immediately, not to “jumpstart” the economy with “fiscal stimulus” –an idea that has repeatedly been discredited over the years — but rather to remove the huge disincentives to work, save and invest produced by taxing income four and five times at high rates, as we do currently. The combined marginal tax rate on capital currently exceeds 60% on average.

– The regulatory wet blanket must be removed from the tech sector, especially telecommunications. This move is necessary to restore rapid productivity growth and allow companies to carry the tech revolution into its next phase.