Monetary policy, one of the levers Washington uses to guide the economy, has eased considerably since the beginning of 1989, when the federal funds rate was 10% and bank reserves were hardly growing.
Today, short-term interest rates are at 30-year lows, yet consumers and businesses continue to pay off debt - the result of a lack of confidence in the economy.
In this environment, the Federal Reserve could push rates down to zero without boosting borrowing. The monetary lever has become as impotent as fiscal policy and exchange-rate policy in pushing the economy forward.
This could be the 1990s version of the 1930s "liquidity trap," a theory advanced by John Maynard Keynes, who pointed out that monetary policy by itself cannot revive a weakened economy.
Indeed, if anything, today's low interest rates may have produced the opposite of what the Fed intended. This is because low interest rates hurt the buying power of many consumers, as interest income now accounts for 13% of personal income, compared with only 6% back in 1960.
Another reason the monetary lever is no longer operative stems from what the Fed has had to do to get rates as low as they are. Bank reserves this year are growing at an 11% annual rate, the fastest since 1987.
This has sent the M1 and M2 (minus small certificates of deposit) monetary aggregates soaring faster than 10% annually, leading a number of economists to express concern that monetary policy is, if anything, too easy.
Concern in Bond Markets
Since most short-term rates are almost as low as they were in 1960, it is pretty clear that the bond markets - where rates haven't fallen nearly as much - are deeply concerned about the government deficit.
Thus, any attempt to deliberately widen the deficit would probably result in a sharp run-up in long-term rates, since even more Treasury paper would be coming to market.
As for altering the value of the dollar in foreign exchange markets, the Fed could ease further to make exports more attractive. But this is obviously impractical. Washington has to sell some of its securities abroad, but would find that difficult if the dollar and dollar-denominated interest rates were falling.
In my opinion, we face not just the one problem of a sluggish economy, but a second problem of the burgeoning budget deficit.
Government as Employer
Since the economy's problems are similar to those of the 1930s, I think the solution can be derived from that era: in the government's assuming the role of employer of last resort.
In the 1930s, this took the form of the Works Progress Administration. In the 1990s, it should involve increased public investment in roads, bridges, water, and sewer systems.
The crumbling infrastructure demands repair, the need to lower costs and increase competitiveness makes this good for business, and the availability of people to do the job makes it good for the economy as well.
By putting people back to work, we can simultaneously address the twin problems of lack of confidence and depressed spending. The fact that steel, cement, and wire cables are produced by the private sector, not by government, will mean an added lift. This will eventually lead to increased hiring, confidence, income, and spending.
The money has already been authorized by the transportation bill signed by the President last year, but not yet widely disbursed to the states. Why not cut the red tape and get the money out?
The government could also cut Social Security taxes, which are draining purchasing power; repeal the luxury tax, which has turned out to be harmful to the producers of high-priced cars, planes, and yachts; cut the capital gains tax, and restore the investment tax credit.
Meanwhile, credit has to flow smoothly through the economy, and regulations must not inadvertently choke it off.
As long as the economy is growing, these measures will reduce and eventually eliminate Washington's deficit.