Fed Rate Cut a Fine First Step by First District Congressman Paul Ryan January 3, 2001 As we make ready for the new year, many Wisconsinites are looking forward with more concern than confidence in the face of slowing economic growth. News commentators have started asking whether the nation might be on the road to a recession, and people are wondering whether the economic slowdown and recent stock market downs are temporary blips or signs of more to come.
It is probably too early to predict this with any accuracy. What we can do at this point is look at what has contributed to weakening economic growth so we can better tackle this problem.
The slowdown can be traced, at least in part, to policies adopted by the U.S. Federal Reserve Board (Fed), which sets interest rates.
The Fed increased interest rates by one percent over the past year in order to fight the threat of inflation. As a result, in December the Fed's key federal funds rate stood at a 10-year high of 6.5%, making it difficult for businesses – especially newly established businesses – to obtain credit. In addition, this affected credit card rates, putting a difficult burden on consumers. The Fed’s justification has been the outdated theory that low unemployment rates and economic growth signal rising inflation.
Meeting on December 19, the Fed signaled a significant shift in outlook – less focus on inflationary dangers and more concern with the risks of economic weakness. And on January 3, in a surprise move, the Fed went further – going ahead with a cut in interest rates. Specifically, the Fed cut the federal funds rate to 6 percent. To be sure, this is a very positive first step, but the Fed should also rethink its main premise.
The Fed should stop relying on the idea that low unemployment rates, strong economic growth, and inflation are necessarily linked. Productivity increases over the past decade have enabled economic growth without substantial increases in inflation. Conventional wisdom dictates that the current Fed position is that low unemployment rates are a sign of an overheating economy. On the contrary, low unemployment rates should be a goal to strive for – not a cause for concern.
Aside from Federal Reserve policy, another culprit partly responsible for slowing economic growth is unreasonably high taxes. Today, individual tax payments are rising faster than increases in personal income. As a result, Americans are suffering under the highest tax burden since World War II, with nearly 40% of the average American family's income going toward taxes.
Much of the present surplus, in fact, amounts to a tax overpayment by citizens. It is only fair that, after shoring up Social Security and Medicare and working to pay down the debt, Congress and the Administration should begin refunding Americans' tax overpayment.
Broad-based tax reductions would help give our slowing economy the boost it needs – leaving more money in Wisconsin families' pockets to save and invest as they see fit.
In the past, such tax cuts have helped the economy during times of slowdown. President Kennedy proposed a broad 30 percent across-the-board tax cut, signed into law by President Johnson, which ushered in the 1960’s era of economic expansion. The economy grew five percent per year for several years following the 1964 Kennedy tax cuts. President Reagan cut taxes in 1981 by 25 percent and cut and simplified taxes again in 1986. The economy grew substantially after each tax reduction. During the Reagan years, the U.S. economy expanded by one-third.
Broad-based tax cuts can strengthen our economy in the years ahead. However, such cuts should be paired with measures that promote fiscal discipline in Washington and work to pay down the debt. One example of this is the lockbox legislation I coauthored in my first term that would safeguard Social Security and Medicare by locking away 100 percent of all Social Security and Medicare payroll taxes and preventing this money from being used for anything except Social Security or Medicare.
Fiscal discipline, a lower tax burden, and sound Fed policy can all contribute to Wisconsin's – and the nation's – economic health. Now that the Federal Reserve has wisely cut the interest rate, Congress and the new Administration should enact fiscally-responsible broad-based tax relief and debt reduction. This would go a long way toward restoring strong economic growth and keeping hard-working Americans employed.