Over the past two years, an output gap -- the difference between actual and potential GDP -- has opened up to roughly $500 billion. The three-quarter-long recession in 2001 deserves much of the blame, but so does a sub-par 2 percent economic recovery since then. Continued 2 percent growth will widen the output gap, raise unemployment further and guarantee that budget deficits at the federal, state and city levels continue to expand.
The most hopeful economic indicator has been the stock market. The Wilshire 5000 index of all actively traded stocks has climbed by roughly 30 percent since last Oct. 9, adding nearly $2.2 trillion to investor wealth. But stocks remain 35 percent below their prior peaks.
The National Association of Business Economists is now predicting 3 percent to 4 percent real economic growth over the next 18 months -- another good omen, one with which I basically agree. But both the stock market and the more optimistic NABE economists are providing forecasts. And these forecasts are surrounded by more-than-usual uncertainty.
Some say that market interest-rate declines have already done the Fed's work; no additional central bank actions are necessary. But the key measure of Fed policy is not their short-term interest-rate target, but the volume of new cash they put into the economy.
That's why recent statements by Alan Greenspan and his vice chairman, Roger Ferguson, sound encouraging. They have suggested that the Fed could purchase 10-year Treasury bonds -- even if this reform is only temporary. Here, too, the issue is not the Fed's theoretical control of interest rates. World credit markets -- not the U.S government -- set rate levels. Instead the issue is conducting open-market operations through 10-year bond purchases, which will pump in new cash just as readily as the Fed's more normal method of buying Treasury bills.
We must not risk another disappointment in the stock market or the economy. That would be devastating. Greenspan and all his little maestros need to pour it on. This is no time to take chances. Add more money. Do whatever it takes to get America humming again. Supply-side tax cuts set the stage for strong economic growth. But it's up to the Fed to show us the money.