Snippets:

(1) Fighting deflation:

Concerned about falling prices, the Federal Reserve cut its target Fed Funds rate by 1/4 of a percentage point to 1% Wednesday (June 25, 2003).

The Fed may have been way behind the curve in its monetary policy decision making. It would have been far more effective in curbing deflation if the central bankers had cut their benchmark short-term rate to 1% more than a year ago when stocks began to fall sharply.

In retrospect, disinflation began in 1997 when the price of gold fell below US$320 per ounce, and deflation became very obvious in 1998 when folks in the business community were talking about over-capacity and over-supply.

When budget surpluses began to emerge in 1997, most people thought it was a great thing, sicne it enhanced the credibility of the U.S. dollar, causing it to strengthen against other major currencies.

Yet, the Federal Reserve was in the mood to "fight inflationary pressures" throughout the late 1990s. To say the least, America's central bankers were out of touch with economic reality. Perhaps, they thought they knew more about the economy than the business community. If they did, they were completely wrong. They should have been modest enough to seek advice from the business community before setting their monetary policy.

America's potential GDP (i.e. the economy's potential to produce goods and services) exceeds aggregate demand (i.e. real GDP) by at least 3 to 4 per cent.

In the first quarter of 2003, GDP grew by only 1.4%, whereas both productivity and the labor force keep growing, further widening the gap between potential GDP and aggregate demand. No wonder, product prices keep falling, not to mention the cheap imports from China.

According to media reports, about 2/3 of the U.S. currency is outside the U.S., much of it is in third-world countries where people save U.S. dollars as a store of value rather than spend their savings on U.S. products. This means much of the U.S. currency outside the U.S. is unlikely to flow into U.S. products and increase aggregate demand or inflationary pressures in the U.S.

(2) Stimulating aggregate demand:

The easiest way to stimulate aggregate demand is deficit spending such as deficit financing of governmental contracts to enable corporationgs to boost earnings and hire more workers, deficit financing of prescription drugs for senior citizens, deficit financing of welfare programs etc.

Such deficit spending is sure to kill deflation and eventually cause inflationary pressures to re-emerge. But why worry about inflation now when risks are "weighted toward" deflation as the Fed has correctly pointed out?

(3) Saving the economy:

In Germany, the jobless rate has risen to 11% as German companies relocate their operations abroad one after another because of Germany's high tax rates, stiff labor laws and business-unfriendly regulations.

Not long ago, German Chancellor Schroder's left-wing government announced that it will make deep tax cuts to save the economy despite Germany's already high budget deficit which accounts for 3.8% of GDP.

What have the Brookings Institution's left-wing "academics" got to say about the left-wing German government's deep tax cuts? Call Chancellor Schroder "fiscally irresponsible" as they do the Bush administration?

Truth is simple; falsehood often is not. And the truth is: textbook prescriptions for economic revitalization usually include tax cuts, interest rate cuts and deficit financing -- as the Brookings "academics" should know if they do read economic textbooks.

No economist in his sound mind should call for budgetary balance or surpluses at this moment. No one with a basic knowledge of economics should call deficit spending "fiscally irresponsible" when America is in the middle of the war on terror and millions of unemployed American workers look to the government for assistance.

Sincerely,

Robert M. Liu