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  • General Discussion

Robert Gordon suggested that Benjamin Friedman was too agnostic about the ability of monetary policy to affect the economy through the housing market and the stock market. In particular, he disagreed with the argument that stock market movements do not affect aggregate consumption because stocks are owned predominantly by wealthy individuals whose consumption responds little to such movements. He also thought the housing market should be given more weight as a channel of monetary transmission, especially over the last five years. There was a growing consensus that Federal Reserve chairman Alan Greenspan held short-term interest rates too low for too long, generating a housing boom that was sustained by complex home equity loans and refinancing arrangements. These developments had implications for consumption, not just housing, and represent a plausible, straightforward channel for monetary policy influence.

Gregory Mankiw found interesting the argument that the press office at the Federal Reserve is more influential than the open market trading desk, but he would have liked to see more evidence supporting it. He suggested that if the Federal Reserve were to shut down the trading desk and operate solely through the press office, the consequences might not support Friedman's hypothesis. Friedman replied that evidence suggests that, after making an announcement, the Federal Reserve typically does not have to conduct open market operations to achieve its desired interest rate. He recognized that open market operations may not be needed precisely because the public understands that they could happen, but he insisted that there is no good model explaining why monetary policy can be conducted without open market operations.

William Gale suggested that one unsettled question about fiscal policy is the trade-off between the stimulative effects of tax cuts in the short run and the drag of deficits on economic growth in the long run; the difference [End Page 72] is important if large budget deficits are a cyclical rather than a secular phenomenon. Gale also wondered about the extent to which the strong economic performance of the last six or seven years could be attributed to tax cuts. The timing of the tax cuts supports a connection, but the sectoral pattern of growth does not. Specifically, the tax cuts did not favor the housing sector and may even have worked against the housing boom by supporting activity in other areas. William Nordhaus emphasized the distinction between the impact of tax cuts on the economy and their utility as a policy instrument, where the latter depends on various considerations beyond the economic impact.

Christopher Sims noted that theories do exist about the optimal ratio of government debt to GDP. A first-order theory is that whatever the level of debt, if the only instrument for lowering it is a distortionary tax, it is best to leave it alone. A second-order theory, derived in a 2000 Brookings Paper by George Hall and Stefan Krieger, is that it is optimal to reduce debt slowly, in order to avoid the higher distortionary taxes needed to service a large debt. [End Page 73]



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