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S. Balakrishnan

ALAN Greenspan, the Chairman of the US Federal Reserve, is as Republican as they come. He was an early follower of Ayn Rand, the libertarian novelist and a sort of philosopher — lodestone for those espousing individualism and the virtues of free market against big Government.

Indeed, Greenspan has been around in the US economic policy-making from the seventies and advised several Republican Presidents.

But his testimony to the US Senate and House of Representatives last week must have come as a sore disappointment to President George W. Bush. The Fed chief thought that the prospect of war added a great deal of uncertainty and was keeping corporate investment on the sidelines. His bombshell came soon thereafter. He felt that the tax cuts proposed by the Bush Administration would only deepen the deficit in the years to come without any positive effect on growth. Left unsaid was perhaps the feeling that the Bush fiscal package was only a naked giveaway to the wealthiest Americans. The only concession Greenspan gave was on the abolition of dividend tax, which would remove the distortions in corporate finance from the anomaly in treatment of debt and equity.

Greenspan has long been a proponent of balanced Budgets. His message to the Clinton Administration was consistent: get the deficit under control and give greater flexibility to monetary policy. Chronic deficits constrain the central bank. If it "accommodates" the deficit, it risks inflation and if it does not relax in times of weak economic conditions because of the poor fiscal situation, growth and employment would worsen precisely when monetary stimulus is needed. His fear is that the Bush proposals would put Government finances in perpetual jeopardy and emasculate the monetary instrument as a tool to revive and stabilise the economy when necessary. Predictably, Greenspan's views drew the ire of the policymakers in the US Government.

The fact is that President Bush lost little time in converting the Budget surplus into a deficit. And it is not just temporary. There is red ink "as far as the eye can see" as The Economist puts it.

The irony is that it was the Republicans who all along have been seen as canons of fiscal virtue while the Democrats were perceived as the big spenders on Government and welfare. A role reversal has since taken place. Economists of Republican persuasion are now arguing that there is no scientific evidence that deficits lead to higher interest rates.

Fiscal looseness will have its costs. Once the geopolitical situation clears up, the safe haven status of bonds will take a knock. A rise in interest rates in coming times looks all but certain.

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