monetary and fiscal policy

SO gets this stuff and has a hard time being patient with the rest of us who struggle to understand the differences. At some level I understand that Greenspan is not the genius that he and others would have your believe. But what is the real story? How can so many people be so wrong about what actual matters in the health and wellbeing of the global economy?

Dr. Woody Brock on GDP
We overestimate the importance of the Fed and monetary policy. And we underestimate the importance of fiscal policy.

Consider the shock to many investors that no recession (defined here as two consecutive quarters of negative growth) accompanied the dual crashes of both capital spending and the stock market during 2000-2002. What saved the day? The answer is that the Bush administration managed to transform a Clinton fiscal surplus of 2.5% of GDP into a fiscal deficit of 3.4% between 2000 and 2003. This is a swing that pushed the level of GDP 6% higher than it otherwise would have been by the end of this period. This number reflected reduced tax revenues from decelerating income growth and policy-determined tax cuts and increased government spending.

“Yet this is rarely if ever cited when observers attempt to explain the events of this momentous period. Instead, economists erroneously attribute stability on Main Street to Greenspan’s dramatic cut in the Fed funds rate to 1%. The reality is that the funds rate only reached 1% in June of 2003. Given the policy transmission lags involved, these lower rates cannot be said to have prevented recession in 2002. Fiscal policy played the key role here.