Promises, Promises: The Elusive Search for Faster Economic Growth

By Schultze, Charles L. | Brookings Review, Fall 1996 | Go to article overview

Promises, Promises: The Elusive Search for Faster Economic Growth


Schultze, Charles L., Brookings Review


The U.S. economy has performed superbly in recent years by way of reaching and maintaining both low unemployment and low inflation. But since the early 1970s, long-term economic growth in America has been disappointingly slow. And projections of future growth, including those of the Congressional Budget Office and the administration, foresee no pickup in the years ahead. While most Americans who want to work have jobs, their incomes living standards haven't been growing much, especially when compared with the halcyon days of the 1950s and 1960s when GDP was expanding 4 percent a year and incomes per family almost 3 1/2 percent.

Not surprisingly, policymakers are looking about for ways to spur faster growth. From all along the political spectrum - from the National Association of Manufacturers to the AFL-CIO, from former Republican presidential hopeful Steve Forbes and GOP vice presidential nominee Jack Kemp to MIT economist Lester Thurow and investment banker Felix Rohatyn - come proposals to alter national economic policies to produce another 1 or 2 percent extra annual growth. (Needless to say, there is no agreement as to exactly what policy alterations are needed.)

If these policies could indeed produce those results, it would be a tremendous boon to the nation. Increasing annual GDP growth from its current 2 percent rate to 3 percent would, if continued for 10 years, add more than $4,000 annually to the $40,000 income of the average American family. A return to 4 percent growth would add $8,000. Notice, however, that a 1 percentage point speedup in growth requires a 50 percent increase and a 2 percent speedup a doubling in the growth that is now forecast!

Faster growth could do more than boost incomes. One percentage point of extra growth would raise federal revenues and lower interest payments on the debt enough to balance the budget at the end of the 10-year period - so long as the growth-promoting policies didn't themselves worsen the budget situation.

What changes in current national policies promise to produce higher growth? How much more growth are they likely to produce? And how much might each help in balancing the budget?

One often-mentioned change involves monetary policy. Current tight Federal Reserve policy, it is said, is a prime obstacle to growth. Whenever economic growth threatens to exceed 2 percent or so on a sustained basis, the Fed has shown itself ready to boost interest rates to prevent the higher growth from being realized. Perhaps a more venturesome policy of credit easing and lower interest rates would produce higher output without setting off inflationary pressures, giving U.S. citizens not only higher incomes, but lower budget deficits as well.

And even if the CBO, the administration, and the Fed are right about current limits to growth, perhaps policies could be devised to improve the nation's future growth potential and allow the Fed to relax its caution. One pro-growth policy is a tax cut. A hotly debated issue here is the extent to which the initial revenue cost of a tax cut is offset by the revenue gains from the faster growth it generates. Two other pro-growth policies are relaxing and improving the economic efficiency of environmental regulation and expanding public investment in education and training.

The Federal Reserve

In times of economic "slack," when workers and industrial capacity stand idle, a Federal Reserve policy of easy credit and low interest rates can stimulate spending-especially on big-ticket items like housing, cars, and business investment-that puts idle workers and capital resources back to work and causes the economy to expand. But once the nation has reached full employment, more big increases in spending spurred by continued easy money policies will overheat the economy and drive up inflation. Beyond that point the nation's spending and production can grow on a sustained basis only as fast as its productive capacity, its supply of goods and services, expands. …

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Promises, Promises: The Elusive Search for Faster Economic Growth
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