Two cheers for Gramm and Solon, but monetary policy isn't the main issue

Fiscal politics catches pundits’ attention, but monetary policy is the ultimate backstop for total spending. Gramm and Solon recognize this. They worry that given the Federal Reserve’s efforts to “eliminate excess demand and bring inflation under control,” failing to curb spending growth will squeeze out the private sector at the expense of the public sector. In other words, they argue that the consequences of the debt ceiling debate for the economy’s health are more dire in an environment of contractionary monetary policy.

Gramm and Solon are right on one count: Failing to constrain government expenditures would weaken markets by diverting resources to unproductive purposes. But the problems with excessive government spending exist regardless of the stance of monetary policy. Even if the Fed were implementing expansionary policy, we’d still get productivity-crippling effects from increased government control. Furthermore, the worst-case scenario isn’t a mere recession. It’s a permanent decline in economic growth.

[Decline is inevitable at these irrational debt levels, but it can be limited with some aggressive action. This isn’t just a spending issue, just like it isn’t just a monetary issue. We need a restructuring of entitlement systems to rationally balance benefits to program income, a move that would have been a hell of a lot easier if we’d tackled it 20 years ago. We also need to recalculate tax and regulatory policy toward supply-side economics to battle inflation in the near and long term, policies that will at least buffer decline while we force ourselves to start paying down that debt and get it back under control. — Ed]