Evans On The Economy -- Whatever Happened To Monetary Policy?

The stock market, more than low interest rates, will drive economic recovery.

Here comes the recovery. Again. The most recent U.S. recession officially ended in November 2001. But for the next six quarters, the economy advanced in a no-man's land, with higher unemployment accompanying anemic real growth. Now, most economists think real growth will pick up to a 4% annual rate by yearend and continue at that rate throughout 2004, which, among other things, should help the Republicans in the 2004 election. As the old saying goes, success has a thousand fathers, so everyone will try to claim a piece of the credit: monetary policy, the Bush tax cut, the reduction in dividend rates that boosted the stock market, the decline in the dollar, the "end" of the war in Iraq, and so on. But in my view, the surprising factor is not that the U.S. economy finally recovered, but that monetary policy started to ease right at the beginning of 2001, yet it took almost three years before the economy returned to above-average growth rates. In the past, monetary stimulus had taken less than one year. In rough terms, since early 2001, when monetary stimulus began, capital spending has declined about 10%, while residential construction and purchases of consumer durables have each risen more than 10%. So there you have it, Alan Greenspan. This time around, monetary policy stimulated consumption and housing but not capital spending, whereas in the past it had stimulated all three components of GDP. You don't have to look very far to find the disconnect: It was the stock market. In the past, sharply lower interest rates boosted stock prices. In 2001 and most of 2002, of course, they had no positive economic impact on the market. Part of the problem was the 2000 bubble, and part was the Enron et al fiasco. As a result, my forecast (along with most others) that the economy will advance at a 4% or better rate over the next year and a half has very little to do with monetary easing or most of the Bush tax cut. It is due primarily to two factors: the recovery of the stock market and the return of the dollar to equilibrium values. Purchases of consumer spending and housing will continue to do well, but they can hardly be expected to accelerate from their recent growth rate of 5% per year. How do I know the stock market will continue to rise? I don't. But the weight of the evidence strongly suggests that it will continue to move substantially higher over the next year and a half, although obviously not every week or even every month. The Bush-Greenspan deal, as I understand it, is that President Bush agreed to appoint Greenspan to another term as Fed chairman ahead of time in return for the unspoken pledge that Greenspan would not raise the federal funds rate until after the 2004 election. So short-term interest rates will remain stable, although long-term rates will probably continue to rise slightly. Profits are finally on the rebound, and vigorous cost-cutting will remain in place. That means, by the way, that higher profit margins will be accompanied by rapid gains in productivity but very sluggish gains in payroll employment. I'm not saying that stimulatory monetary and fiscal policy didn't play their role over the past two years: They kept consumption and housing afloat, and kept the recession short and mild. But for above-average growth to return, capital spending must kick in, and that never happens until the stock market recovers. Michael K. Evans is chief economist for American Economics Group, Washington, D.C., and president of the Evans Group, an economics consulting firm in Boca Raton, Fla.

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