Martin Feldstein: The Danger Ahead

By Maria Bartiromo

Shawn G. Henry

Harvard economist Martin Feldstein, who was chairman of the Council of Economic Advisers under President Reagan and on the short list to succeed Alan Greenspan at the Fed, is worried that the economy will teeter into recession. He believes the Fed will lower rates on Dec. 11 by at least 25 basis points, and he strongly advocates further cuts into 2008. Beyond that, Feldstein, who is also president and chief executive of the National Bureau of Economic Research, would like to see a temporary tax cut put in place now that would be triggered by economic conditions next year. He also says he is not worried about the drooping dollar and contends that it needs to fall further to make America competitive in world markets again and shrink the trade deficit. We talked on Dec. 4 in anticipation of the Fed cut that almost everybody on Wall Street is expecting.

Maria Bartiromo

When you were at the renowned Jackson Hole [Wyo.] economic conference at the end of August, there was talk that you were pushing for a 100 basis-point cut in interest rates. Is that true?

Martin Feldstein

That was exactly what I said. I gave a talk there in which I said I thought the economy was much weaker than many people recognized and the Federal Reserve should bring its rate down from what was then 5 1/4%, over time, by a full 100 basis points.

Did you get a lot of pushback?

A number of people were skeptical. And subsequently in the discussions at the Federal Open Market Committee, a number of the members resisted bringing rates down that much. But it looks like on Dec. 11 [at the FOMC meeting] they're at least going to complete that 100 basis-point reduction.

So you're expecting a 25-basis point cut on Dec. 11?

I would say at least 25 basis points, and I think that going forward [the Fed] has to continue to cut unless the economy produces some signs of a real economic turnaround.

How likely is that?

Right now, I don't see it. There are few positive indications. Consumer confidence is weak. Surveys show overall business activity is hovering just on the border between increasing and decreasing, and, obviously, housing continues to deteriorate.

So you expect the cycle of rate cuts to continue?

I think it'll continue into 2008. And I think it will help. Lower rates are not going to turn around the price of oil, and they're not going to deal with the credit crunch directly, but they will stimulate spending in the economy by reducing the cost of borrowing. Lower interest rates will mean that adjustable-rate mortgages will come down for some people, and that'll free up more spending power. Lower interest rates can help. I'm just not sure they can help enough. So the time has come to think about some kind of fiscal stimulus.

In what form?

The thing I've been thinking most about is a temporary personal tax cut to be enacted now but triggered by what happens to the economy in 2008. It could be an across-the-board percentage cut; it could be a flat amount per taxpayer. That's sort of secondary in my thinking. The key thing is to enact it now and trigger it based on something like what happens to employment next year.

With all the talk, though, from the Democratic side about raising taxes, do you think your plan can fly?

They are talking about letting the Bush tax cuts lapse, and that would be a tax increase. And I think that would have an adverse effect, not only when it happened, but even in anticipation as people realize that their aftertax incomes would be coming down. But what I have in mind is something that I don't see the Democrats opposing because it would be a temporary reduction aimed at stimulating the economy.

I talked with Republican Presidential candidate Ron Paul last week, and he likened the economy to a drug addict who needs that fix of lower interest rates from the Fed. Is there a point at which it would be more beneficial in the long run to tough our way through a recession?

I don't think we need a recession at this point.