Policymakers Face Economic Challenge: Can They Learn?

Even before the September 11 attack on the United States, there were many signs that the American economy was tipping into a recession, the first since 1991 and only the second in the last eighteen years. For days after the attack Americans were, to their credit, focused on the human toll and on the state of war into which they had suddenly been thrust. Now Americans are beginning to notice the economic destruction left in the terrorists’ wake, as well. What was already emerging as a key challenge to the Bush administration in the months ahead has become more severe and must be addressed in a radically different environment.

The key goal, as in any recession, must be to prevent a short-term recession from turning into something much worse. Numerous safeguards against depression exist now that did not exist in 1929-32. Nevertheless, just as good policy can speed recovery, bad policy can worsen and lengthen any economic slowdown. It is clear, for example, that three enormous errors by federal policymakers combined to turn the slowdown that started in 1929 into the Great Depression:

1. The Federal Reserve Board, wishing to maintain the value of the dollar, actually raised interest rates and failed to make upward adjustments in the money supply. Some analysts argue that even a relatively small infusion of money into the banking system in 1929-30 could have prevented catastrophe.
2. Congress and President Hoover, bound by a rigid commitment to balanced budgets, instituted large tax increases and sometimes draconian budget savings measures. Despite their best efforts, budget deficits ballooned anyway. Then, as now, federal balance sheets more often reflect economic conditions than produce them.
3. Congress and the President, against the nearly unanimous advice of professional economists, enacted the Smoot-Hawley tariff, a protectionist measure aimed at saving American industrial jobs. Instead, Smoot-Hawley cut off international commerce, worsening economic conditions both in America and abroad.

The lessons of that episode are not difficult to understand. Fortunately, policymakers—at least so far—seem to have taken at least some of them to heart. The Federal Reserve Board, for example, reacted to the terrorist attack by cutting interest rates an additional one-half percentage point, the latest in a string of rate cuts aimed against economic sluggishness.

Furthermore, federal fiscal policy, under the pressure of crisis, has abandoned the so-called “lock-box” concept that would have maintained sacrosanct the accounting fiction of the Social Security surplus. Whatever their notable differences, Franklin Roosevelt and Ronald Reagan understood an important truth about fiscal policy: a balanced budget, while desirable in the abstract, is never an end in itself. It must be considered subordinate to the demands of economic stability and national security. Prior to September 11, there was a real danger that both might be sacrificed to an absurdly rigid, and almost entirely politically-driven, fiscal regimen. The irony, of course, was that George W. Bush was tentatively inching his way toward representing the Roosevelt/Reagan position while Thomas Daschle and Richard Gephardt had wholly embraced the Hoover position. That debate as it existed on September 10 is over.

This is not to say the debate might not be resurrected in a different form. Calls will almost certainly be heard in the months ahead for the administration to accept a scaling back or cancellation of the tax cut passed last summer, not to preserve the “lock-box” but to pay for defense. It should stoutly resist such calls. Instead, it should use its new freedom of fiscal action to move more aggressively on the economic front, perhaps accelerating the tax cuts or adding new ones.

The area where Congress seems most likely to repeat the mistakes of history is in the area of trade. On one hand, trade is already much freer than it was at the beginning of the Great Depression. On the other hand, President Bush is seeking the restoration of “fast-track” trade negotiation authority, a privilege enjoyed by every President starting with John F. Kennedy until it lapsed under Bill Clinton. Defeat of “fast-track” would be a blow to international commerce that could not come at a worse time.

Complicating the task of economic recovery will be the ongoing psychological impact of the war with terrorism. Even if all the right economic steps are taken, Americans may be reluctant to spend and invest if they remain uncertain about the future. The best, and perhaps only, antidote to that malady must come from the American people themselves. A heartfelt defiance of our enemies has kept us free for two hundred and twenty-five years. We depend on that defiance now to keep us prosperous, as well.

Andrew E. Busch is an Adjunct Fellow of the John M. Ashbrook Center for Public Affairs and an Associate Professor of Political Science at the University of Denver, where he specializes in American government and politics. Dr. Busch is the author of Ronald Reagan and the Politics of Freedom. He is also the co-author of The Perfect Tie: The True Story of the 2000 Presidential Election.