Stagflation Nonsense

Three months ago, the first government estimate of gross domestic product for the fourth quarter of 2004 came in at a 3.1 percent annual rate. The market consensus was 3.5 percent growth. Immediately, the mainstream media started talking about an economic slowdown. Turns out, that 3.1 percent was revised up to 3.8 percent.

This past week, the Commerce Department reported its initial estimate for first quarter GDP at 3.1 percent. The consensus forecast was 3.5 percent. Immediately, newspaper headlines screamed about an economic soft-patch and the likelihood of further decline. Sound familiar?

Well, history is repeating itself — even though, if you look under the GDP hood, you’ll find that the country’s economic engine is humming along.

Is the media simply interested in a putting out a declinist view of America? Is this just more Bush-hating? Why don’t the pundits pick on Western Europe or Japan, places where economic growth is less than 1 percent? Ours is a healthy, prospering economy.

The media notwithstanding, the culprit for lower-than-consensus GDP was once again higher imports (net of exports), which are really a sign of economic strength. Imports subtracted about 1.5 percent from the first quarter’s apparently lackluster GDP number. But stick that back in, and GDP would be 4.6 percent.

The trade gap subtracted $663 billion out of an $11.1 trillion real GDP. But consumers and businesses are buying heavily because incomes and prosperity are up. The trade-deficit accounting is “Alice in Wonderland” stuff. The measure of real gross domestic purchases, which excludes trade altogether, came in at 4.4 percent annually, a strong performance.

There has, in fact, been a temporary slowdown in business capital-goods investment, according to Wall Street economist Michael Darda, owing mostly to the expiration of the corporate tax cash-expensing bonus. Congress should put this back in the budget, but even without it, business cap-ex will pick up speed as companies are flush with cash and profits are at record highs. Finally, consumer spending and the housing sector were both quite strong in the latest GDP report.

One reason the media keep looking for a double-dip recession is that they continue to underestimate the pro-growth impacts of supply-side tax cuts. In the seven quarters following the Bush tax cuts of June 2003, the core private economy (GDP minus trade and government spending) increased at a 5.6 percent annual rate. In the seven quarters before the tax cuts, the economy increased at only a 2.7 percent annual rate.

Remember, the tax cuts of 2003 contained strong supply-side incentives to work and invest. The top marginal rate on individual income was lowered to 35 percent from 39.6 percent. Even a more powerful incentive-boost came from the cut on the tax rate for investor dividends, which plunged to 15 percent from 39.6 percent. And let’s not forget the capital-gains tax cut that lowered the top rate to 15 percent from 20 percent. Fortunately, Congress’ new budget extends the tax cuts on dividends and cap-gains from 2008 to 2010.

For work and investment, Uncle Sam keeps a lot less nowadays, while individuals keep a lot more. Private capital goes up, while the government’s take goes down. Consequently, the private economy has a much stronger growth engine today. Quarterly GDP may bounce up and down, but the trend line has improved markedly in recent years.

As for inflation, Alan Greenspan’s favorite measure, the chain-weighted price index for personal consumption spending, increased only 2.2 percent in the first quarter. Excluding energy, it was up only 1.8 percent over the past year, a pace that is lower than the 1998-2002 average, according to Washington economist Alan Reynolds.

Meanwhile, commodity prices are weakening and the air is gradually coming out of the oil bubble. As former Fed Governor Wayne Angell notes, the recent commodity slump shows that the central bank has done its job well by gradually slowing the money supply and raising its target rate.

Bond yields remain near 45-year lows, more evidence of quiescent inflation. But as real-time market-price indicators stabilize, it is time for the Fed to cease tightening.

If you listen too hard to pessimistic pundits, you can get all lathered up over the risks of stagflation — slower growth and higher prices. Don’t go there. This is not the 1970s. Money is sounder, tax rates are lower, productivity and profits are much higher, and world trade is more open. Today’s technology-streamlined and deregulated economy is not inflation-prone.

So long as the Bush administration and Congress control spending, keep tax rates low and avoid the growth-slowing pitfalls of trade protectionism, non-inflationary prosperity can continue for years to come.

Economic policies matter, and right now they are pro-growth.