Starving the Beast

Inflation-targeting, unless someone is keeping a big secret from us, is the only arrow in the quiver of a nation's central bank, in our case the Federal Reserve. We think there is reasonable evidence to believe that adjusting interest rates and the supply of money was powerful enough to keep inflation less than 3% for two decades. And avoiding inflation was enough to prevent recession. We think Paul Volcker may have proved the issue in another way. During the Carter Administration, the country experienced "stagflation", meaning we had inflation and economic stagnation at the same time; making one better might well make the other worse. But Volcker promptly jacked up interest rates a great deal -- and both inflation and economic stagnation then seemed to go away.

If inflation targeting is a powerful as that, and as simple as that, what could go wrong? One present worry is that so much American money might fall into foreign hands that the Federal Reserve could lose control of whether there is too much or too little within our borders. But there is a second source of danger. Broadly speaking, this concern is that public opinion might demand inflation -- or demand policies which would surely cause it -- and in a democracy the time might come when the Federal Reserve would have to give people what they demanded. You could even conjecture that Ronald Reagan warned us about that.

Government isn't the solution, government is the problem, were words of a California governor. And yet neither Reagan nor the two Bush presidents who followed him made the slightest apology about increasing the federal deficit. It is a Democrat, Governor Corzine of New Jersey, who has been thrown to the lions in 2006. We are about to watch one of the most eminent financiers of the country come to the public realization that no accounting trick or delaying strategy is available to help him avoid a public confession of what is wrong, and adopt a correction for that problem rather than an aspirin for its pain. You don't get to be chief of the largest investment bank on Wall Street without being fast on your feet, so we will be treated to some fancy tap-dancing before he addresses the painful issue. But the Republicans will surely help him blurt it out, if he seems to hesitate.

For a number of decades, New Jersey has been increasing the number of state employees and their pension and health benefits. As is so often the case, these state employees and their union have become the core voting bloc for the party in power, usually Democrats. Not only are there a remarkable number of employees observable in each of the local offices for the Bureau of Motor Vehicles for example, but New Jersey decided to include the local municipal and school employees in the state health and pension system, a decidedly unusual step. These are not trivial costs. As life expectancy gets longer the pensions become more expensive; the health benefits get more expensive by raising health worker wages and by offering more generous home and nursing home care. Just how a ten-mile ambulance ride gets to cost $1700 is a related story, passed over here. And then, a few years ago it seemed like clever bookkeeping to float a bond issue to bring the state pension system up to required full funding. Long term full funding tends to mean a stock portfolio, so buying stocks with the proceeds of a bond issue is the same as buying stock on margin. By a stroke of exceedingly bad timing, the stock market promptly responded to the dot-com boom by crashing, taking the state's margined stocks down even farther, faster.

New Jersey has always had high real estate taxes, and they are now painfully high. But Jersey residents used to console themselves that they had no sales tax and no income tax. Now, the sales and income taxes are in the top five states of the country, and just about every other form of state taxation has crept up to painful levels. Doesn't matter, the state is running a $5 billion deficit and will run a greater deficit than that for as long as anyone can predict. Forbidden by the courts to borrow money, it's not easy to see what Corzine can do except raise taxes some more. Well, perhaps there is one thing, if the unions will let him. He can extend the retirement age of state employees from the present age 55, to age 75.

Just try to do that without anyone noticing.

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