Talk about the Grinch who stole Christmas. The signs that the economy is slowing are cropping up everywhere. Consumer confidence has tumbled during the holiday season. The unemployment rate has ticked up. A growing number of Wall Street traders and analysts are convinced that the 17% decline in the NASDAQ this year signals a "recession" for next year. What accounts for the slump? Some of the downturn reflects the normal ebb and flow of economic activity in a dynamic capitalist system. Higher oil prices are crimping consumer spending. Companies are cutting back on capital spending plans.

Policy makers have also contributed to the downturn. The Federal Reserve's tight money policy is a drag on the economy. Fiscal policy is tight with a federal budget surplus at a record 2.4% of gross domestic product. The good news is that for the first time in three decades, both fiscal and monetary policy are well positioned to combat a downturn in the business cycle. Already, investors are anticipating that the Fed will ease by early next year if not next week when the Federal Open Market Committee meets.

Mortgage rates have dropped by almost a percentage point since the beginning of the year. Short-term interest rates are also down sharply. Should Congress and the Administration also "ease?" No. The experience of the past several decades suggests that policy makers can't cut taxes or hike spending quick enough to affect the economy in the short-run. What's more, the impact of fiscal policy changes is very uncertain. Remember when Clinton's 1993 tax hike was supposed to send the economy into a recession? Instead, the markets rewarded fiscal discipline and the economy strengthened. In coming weeks, you'll hear a lot of heated rhetoric about the need for massive tax cuts to avert economic collapse. Don't buy it. For one thing, the economy is healthier than the recession mongering suggests. Even more important, while there is a strong case for tax reform, there is little argument for trying to fine-tune the economy through fiscal policy.

 


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