Alan Reynolds

Whenever Fed Chairman Alan Greenspan testifies before Congress, as he did on Wednesday, legislators are fascinated with what they can get him to say about fiscal policy -- budget deficits. Stock and bond investors only listened to what he had to say about monetary policy. Stocks and bonds did not rise that day because investors thought Greenspan's familiar anxieties about budget deficits were newsworthy or bullish.

Why do investors pay no attention to Greenspan's warnings about budget deficits? Because they know these warnings are based on archaic theoretical conventions that have recently been well tested and found false.

Greenspan described deficits, for example, as making "demands on national savings." The idea is that government borrowing must be subtracted from an otherwise fixed amount of saving. Proponents of this idea imagine that if tax collectors would simply take more money from the private sector and give it to the government, the sum of both public and private budgets would be magically improved. It is on the basis of this sort of imaginative bookkeeping that Greenspan and others once predicted that moving from deficits to surpluses would greatly increase the "national savings rate" (public and private saving as a percent of GDP).

Did moving to surpluses from 1998 to 2001 really raise the savings rate? The Fed's Policy Report to the Congress says it did: "The federal government had contributed increasingly to national savings in the late 1990s and 2000 as budget deficits gave way to accumulating surpluses." Those words sound comforting, but the facts are not: From 1998 to 2001, the budget was in surplus and national savings was 17.5 percent of GDP. From 1981 to 1989, when budget deficits averaged 3.8 percent of GDP, the national savings rate was higher -- 18.2 percent.

The Policy Report insinuates that budget deficits caused the savings rate to fall in 2001-2002. Nice try. In reality, recessions cause budget deficits and also shrink the sources of savings (profits and jobs). Savings rates are always lower in the wake of recessions -- 14.7 percent in 1993, for example, and 14.6 percent rate of 2002.

The report graphs "net" savings (after subtracting estimated depreciation) as a percent "gross" domestic product (with depreciation added back in). Yet even that dubious "net" savings rate was still smaller when the budget was in surplus (5.6 percent in 1998-2001), than when deficits were large in 1981-89 (6 percent).


Alan Reynolds

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