was quite clear last week about the "what" of the economic and financial outlook. The "how" of that outlook is much murkier.
But before we delve into these issues, class, let's review the simple politics of economic policy in Washington.
To tighten monetary policy is to practice bad politics. Easing is good politics. On the fiscal front, cutting taxes and/or raising spending is good politics. Raising taxes and/or cutting spending is bad.
That's quite straightforward. Every last member of
understands this, so it should pose no difficulties for you. Let's now rearrange these elements.
Good politics: Ease monetary policy, cut taxes and increase government spending. Bad politics: Tighten monetary policy, hike taxes and trim spending.
You'll notice that the effect on the economy of good politics is stimulative. These actions tend to speed up activity in the private sector by leaving more money in household and business budgets after April 15 by increasing the availability of government contracts to be won and government green checks to be harvested from mailboxes and by increasing the availability and/or lowering the cost of credit. The effect of bad politics is precisely the opposite -- which is why it is bad politics.
Rearrange once again and note that monetary policy is the purview of the
, which jealously guards its perquisites. Fiscal policy is managed by Congress and the administration, which means that it's in the public domain and subject to the advice of anyone, including the Fed chairman. But note further that the Federal Reserve is a "creature of Congress," created by act of Congress and subject to its authority or whim.
The Fed is in fact the central bank, the bank of the government, and Alan Greenspan is a government official. He and his colleagues are somewhat insulated from the day-to-day hurly-burly of politics by long-term appointments in order to enhance the likelihood that they will do the right thing in the interests of the economy and the country. This fact helps to explain why it is only Fed officials who have talked lately about the need to practice bad politics.
Greenspan says an economic slowdown is necessary. The "profoundly beneficial forces driving the American economy to competitive excellence are also engendering a set of imbalances that, unless contained, threaten our continuing prosperity." Good economics, in his view, now requires bad politics. And he would greatly appreciate some help in bearing that burden. He encourages Congress to preserve the fiscal surpluses that are now projected for the years ahead. Ever-larger fiscal surpluses create a drag on economic activity -- government surpluses are, in the view of many, prima facie evidence of overtaxation.
But he is no babe in the ways of the beltway: "... I recognize that growing budget surpluses may be politically infeasible to defend," and he then counsels that if the urge to practice good politics can't be resisted, tax cuts are much to be preferred to spending increases.
It may seem bizarre that one set of government officials practices good politics, as defined above, while another practices bad. But consistency is the hobgoblin of petty minds, of which there are none in Washington, so working at cross-purposes is classic economic policy. The likely implication is that it will take more bad politics, in the form of monetary tightening, to offset the effects that good politics, in the form of tax cuts, will have on an economy that is at risk of overheating.
In short, the "what" of Greenspan's
outlook is that the economy will slow, or will be caused to slow. As to the "how" of it, there was the following: " ... with the assistance of a monetary policy vigilant against emerging macroeconomic imbalances, real long-term interest rates will at some point be high enough to finally balance demand with supply at the economy's potential in both financial and product markets. Other things equal, this condition will involve equity discount factors high enough to bring the rise in asset values into line with that of household incomes, thereby stemming the impetus to consumption relative to income that has come from rising wealth."
These thoughts reinforce his previously uttered definition of the "wealth effect" as a rising ratio of wealth to income. For the past three years income, i.e.
, has risen by a sprightly 4%. The
has topped 20% in each of the past five years, while the
has made that historic performance seem something to be ashamed of. The Greenspan solution then, roughly, would be 4% returns to equities for a period ahead until "macroeconomic imbalances" no longer threaten "our continuing prosperity." Won't that feel different?
But financial markets, like government policy, are riven by crosscurrents. Most interest rates are drifting higher in nervousness about Fed intentions, but long Treasury bond yields are moving lower. They are a special case, however temporarily, as the market operates under an impression that current surplus projections will in fact be realized. Good politics suggests otherwise.
Old Economy stocks -- or the
, the S&P or the
-- have begun to struggle as the outlook for higher interest rates works its traditional effect. New Economy stocks are still too new to have a tradition or to respect anyone else's; the Nasdaq continues to levitate near its record high, having doubled in the past 12 months.
And now, class, a pop quiz. Imagine that you own a balance of each sort of stock, both Old and New. Assume that Chairman Greenspan means what he says and that he goes on to accomplish what he means. That is, assume an increase in "wealth" no greater than the prospective increase in income. What are the implications for Old Economy stocks if New Economy stocks are in fact immune to Fed action? For extra credit, what are the likely differences in performance between these two classes if in fact New Economy stocks prove to be susceptible to Fed action?
Ten minutes until the bell. Please leave the blue books on the desk on your way out.
Jim Griffin is the chief strategist at Hartford, Conn.-based Aeltus Investment Management, which manages institutional investment accounts and acts as adviser to the Aetna Mutual Funds. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. While Griffin cannot provide investment advice or recommendations, he invites you to comment on his column at