Martin Feldstein projects “Solid Growth” at Bradley Distinguished Lecture Series With strong growth rates, low inflation, and low unemployment, the American economy today is in very good condition, according to Harvard economist Martin Feldstein.
And looking ahead, Feldstein sees continued solid growth for 2005.
Noting that real earnings are rising at more than six percent and consumer confidence is at a near-peak level, Feldstein is further encouraged by business investment, strong corporate profits, very substantial retained earnings, rising capacity utilization, strong industrial production, and planned investments.
Feldstein provided his views on the economy at the Bradley Distinguished Lecture Series at the Hyatt Regency Milwaukee in February. The lecture was sponsored by the Lynde and Harry Bradley Foundation and the UWM Sheldon B. Lubar School of Business.
Martin Feldstein is the George F. Baker Professor of Economics at Harvard University and President and CEO of the National Bureau of Economic Research. He served as Chairman of the Council of Economic Advisers and President Reagan’s chief economic adviser from 1982 through 1984. Feldstein has been mentioned in the national media as a possible successor to Federal Reserve Board Chairman Alan Greenspan in 2006.
Current Account Deficit The most serious issue impacting the U.S. economy, Feldstein told the audience, is the U.S. current account deficit with the rest of the world, which runs close to $700 billion per year – more than 5% of gross domestic product (GDP). The current account deficit is the sum of the trade deficit plus net investment payments to the rest of the world.
More significant than the deficit itself, he said, is the way this shortfall of funds is being financed. In the past, a significant portion of foreign money coming into the United States was in the form of equity investing. Now, much of the inflow of funds comes in the form of debt – foreigners buying U.S. bonds.
Feldstein views this as a precarious situation. A reduced willingness on the part of foreigners to buy bonds would result in higher interest rates to attract those funds and a further reduction in the value of the dollar, he said.
Need to Increase U.S. Savings RateIncreasing the U.S. savings rate would allow us to finance our investment domestically, according to Feldstein.
He identified the “special economic circumstances” that led to a decline in the U.S. saving rate over the last decade, including the tripling of the stock market, a dramatic increase in home prices, and sharp falls in interest rates that allowed people to refinance their homes, take out cash, “and still have lower monthly payments.”
In the future, however, he projected that households that want to build wealth are going to have to do it “the old-fashioned way” – they will have to consume less of their after-tax income.
“I’m optimistic that this can be solved without any special new policies,” he said. “It will be natural market reaction.”
Inflationary PressuresWith regard to inflation, Feldstein believes that inflation remains basically under control. However, he said that pressures exist for rising inflation in the coming year “and probably beyond.” Those pressures include increases in the price of oil and non-oil import prices because of the weak dollar, as well as increasing unit labor costs.
“We were in a remarkable position in 2002-2003, when productivity was growing so fast that productivity growth was outpacing the growth in wages, and therefore unit labor costs were coming down,” he said. “But that has ceased to be true.”
Feldstein believes that the Federal Reserve Bank will closely monitor these external and internal pressures, adjusting the federal funds rate – the rate banks charge each other for overnight loans – to keep these pressures in check.
Fiscal Deficit Too HighThe nation’s fiscal deficit, Feldstein said – though forecast to come down slightly from last year’s $412 billion level – is still too high.
“We’re accumulating debt faster than the economy is growing. A higher debt to GDP ratio means crowding out business investment in plant and equipment and sucking in funds from the rest of the world,” he said. Ultimately, he added, that debt has to be serviced through higher taxes.
Feldstein said that it is possible to bring down the fiscal deficit, assuming that tax cuts are made permanent, the alternative minimum tax is changed or eliminated, and discretionary spending is controlled.
“It’s not a sure victory, but it’s a manageable problem if spending can be kept under control,” said Feldstein.
Social Security Reform“Social Security is the major long-term fiscal problem,” Feldstein told the audience.
And in his opinion, reform will happen. “The President is determined to change the system,” he said.
He described the “Bush Approach” as a mixed system combining the existing tax-financed, pay-as-you-go system with an investment-based, personal retirement account component.
In essence, he explained, one part slows the increase in the pay-as-you-go benefits so that there’s no need to increase taxes as the population ages. At the same time, the tax-financed benefits are supplemented with annuities from the personal retirement accounts.
“I think this is a feasible, good solution, that – if designed right – will maintain the future levels of retirement income that people are expecting,” Feldstein concluded.
