The fundamental question for the U.S. macroeconomic forecast is if the pandemic recovery can continue or if the economy is heading into a recession. This outcome will be determined largely by Federal Reserve actions during the quarters ahead. Given how long the Fed waited to fight the current bought of inflation, it is not likely they can return inflation to its target rate without monetary policy changes which would also induce a recession.

It is an open question if the Fed has the fortitude to follow-through fighting inflation. The forecast then, is either for recession, or anemic growth accompanied by continued inflation.

CERF’s baseline forecast embodies the assumption that the Fed will cease substantive hikes by December 31^st of 2022 and that the economy will not be pushed into recession. We do have one 25 basis point hike in early 2023, but no other hikes. This is a low confidence forecast, since it necessarily involves predicting the behavior of a body of political actors at the Fed.

This forecast for the Fed’s policy rate has implications for inflation. Inflation, with substantial momentum at the current time of writing, will not be much reined in by this forecast of Fed policy.

How strong is the Fed’s policy stance on inflation? The real ten-year Treasury yield was -3.1 percent using September yields with the core PCE deflator. As conventional wisdom has always argued, a negative interest rate of that magnitude indicates policy that is massively stimulative.

The presumed level of short term interest rates under this forecast scenario is that they reach 4.625 percent (based on the midpoint of the Fed’s target range) by mid-2023. By the Fed’s own analysis the rate needs to be above 6 percent in order to adequately combat inflation.

Inflation will subside, but it will not subside quickly, and the real 10-year Treasury yield will remain in negative territory for all of 2023, indicating that instead of being restrictive, the Fed’s policy will remain stimulative, for about a year.

We forecast that the Core PCE deflator will still be 4.8 percent at the end of 2022, and that it will still be 4.3 percent at the end of 2023. This is higher than the consensus forecast of 3.2 percent, but our forecast is lower than inflation expectations, such as the University of Michigan’s survey value of 4.8 percent.

This forecast is one where rates are not really that high. The chart below shows the third quarter real 10-year Treasury is still quite negative, and it shows real rates during the Volcker policy era in the early 1980s that did succeed in fighting inflation, and also pushed the economy into recession.

Because rates are not really that high, inflation will remain persistent, and, growth will be weak but positive. We do not forecast a recession in this scenario, in part because rates are not actually that high. They will not get high enough to halt inflation, and they will not be high enough to cause a recession.

CERF has argued that monetary and fiscal policy has been much too stimulative. While it is possible to justify stimulating the economy in the time of crises, policies have been a ratchet, ramping up support through payments and credit in times of crises and not subsiding thereafter. This occurred after the 2007-08 financial crises and again during the Pandemic in 2020.

Overly-stimulative policies help us understand the macroeconomic environment we are in today. Some forecasters are saying that the Fed’s impotence against inflation, with 300 basis points of hikes in seven months having failed to slow inflation momentum, has surprised almost everyone. This does not surprise CERF. The economy is overstimulated. According to CoBank estimates the U.S. household sector still has $2 Trillion in excess savings. And, we point to the most recent University of Michigan survey data, which as of October showed consumer’s expect inflation will still be 4.8 percent a year from now.

There are risks to this forecast. One alternate scenario is that the Fed does continue raising rates aggressively during 2023, sending the short term policy target well-over 6 percent. In this scenario, the real 10-year Treasury yield would surge into positive territory more rapidly, inflation would subside more quickly during 2023, and the economy would experience a recession.

Why is our baseline case that the Fed does not get in front of inflation? They have shown before that they are sensitive to markets, especially, the stock market. In October of 2018, they announced a balance sheet normalization policy that sent the S&P 500 into a 24 percent decline in just 3 months. On January 4, 2019, Fed chair Jerome Powell signaled a reversal of policy normalization, and in March of that year, stated that a multi-trillion dollar balance sheet might go on indefinitely. This of course, gave rise to the notion of QE-infinity, the idea that the Fed would never normalize policy.

The effect of significantly higher rates will have an important follow-on effect of raising the debt service costs for the U.S. This is more of an issue now, where the debt to GDP ratio is 120 percent, a historically high level for the U.S. This will be another source of pressure against further Fed rate hikes to levels above 5 percent.

CERF’s economic forecast for the next eight quarters is for growth substantially below potential. Many forecasters, including the Fed, point to demographic factors and make post-industrialized economy arguments to rationalize below potential growth. CERF disagrees. Most of the sub-par growth is driven by poor policies, policies that throw a blanket on what would be a much more healthy and robust economy.

Monetary and fiscal policies should follow policy rules, or a logic that is guided by economic theory and analysis. Policies since 2008, especially monetary policy, have been ad hoc. They depress economic activity through the specific disincentivizing impacts they impart on investing for the future, but in addition, they depress the economy through policy uncertainty. This uncertainty doesn’t just add difficulty to forecasting, but it also reduces the ability of households, establishments, and governments to make decisions for their, and the our nation’s, future.

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Readers of CERF blogs and forecast publications know that CERF economists are critical of the Fed’s monetary policy, and have been for seven years now.  The Fed’s policies starting in December of 2008 were extraordinary, unprecedented, not recommended by economic theory, and have contributed to anemic growth and wealth generation for the past decade.

Prior to December of 2008, the Fed mainly relied on one policy tool, the Federal Funds Target rate (FFRT).  During the dark days of the financial crisis, they added two more policy tools, quantitative easing (QE) and interest on reserves (IOR).  CERF is most critical of IOR.

There are a few things that economists agree on, and one of them is that financial intermediation is good for the economy.  This is the process by which banks use savings deposits as a pool of funds to extend credit to businesses and households.  The IOR reduces the quantity of loanable funds available for intermediation by taking them out of the banking system and locking them up as reserves at the Fed.  Lending falls, investment expenditures fall, growth slows, and capital accumulation and future wealth fall.  These are unmistakably bad economic outcomes compared with having those funds available and extended to households and businesses who are growing.

What’s more, it is not clear how the Fed would respond if there were a severe recession tomorrow.  If they raised IOR, this would further restrict credit.  They could reduce IOR, but in a severe recession, weak loan demand would make this less effective.

It is clear that the Fed wants to maintain a massive balance sheet, and they have documented various technical benefits.  However, it is fearful of rapidly unwinding it, and this is the real reason for the glacial reduction pace.  A consequence of the Fed’s massive balance sheet is that it destroys the Fed’s ability to control short term interest rates.  IOR, a rate that the Fed sets directly, provides the short term interest control they desire.  The interest rate on reserves may actually be the most impactful policy that the Fed is employing, but that is only because unwinding the balance sheet would wreak unknown but horrible damage to the economy.

CERF economists have also criticized the fact that the Fed’s policy statements highlight the FFRT and QE, but IOR information is no longer provided in the Fed’s main press release.  Since December of 2015, changes to IOR have been deliberately buried in a technical note separate from the press release.

At the panel, Chair Powell and former chair Bernanke stressed the Fed’s goal of being transparent.  They repeated their desire to clearly and frequently communicate their policy intentions to the world.  However, not one word was uttered about IOR at any point during the one-hour long discussion on Monetary Policy.  It was clear this was done on purpose.  Neither the press nor the economics profession have properly brought the IOR policy and the resulting economic detriment to light until recently.  In particular, the January 1^st Wall Street Journal article, The Fed’s Obama-era Hangover by Phil Gramm and Thomas Saving, highlights the powerful impact of IOR on credit.  The article also explains that the Fed is now an interest rate follower.  It is no longer setting or leading short term rates.

It is clear that the Fed’s stated transparency goal is contradicted by the reality of the Fed’s actions.

I have a theory to explain this contradiction.  As forecasters, CERF economists routinely promulgate their economic analysis and their forecasts to the press and the community.  This is a challenge.  Economics is a complicated undertaking.  There are subtleties and complexities.  It happens that we’ll interview with the Media and then read their article and wonder what went wrong because the written article miss-represents our views and/or our analysis.  This appears to be a reality of the interface between economists and non-economists.

We have tools to deal with this issue.  We tell stories as much as possible.  We try to pull back from talking about many relevant factors to focus on one key factor.  But these strategies do not always work.

It may be that the Fed does not talk about IOR because it is difficult to explain.  There is more to IOR than the financial intermediation impact, as the Gramm and Saving article reveals.  The complexities include IOR interaction with other policy tools and various aspects of the economy.  It is difficult to explain to the public, in fact, even to economists who do not follow monetary policy closely.  Perhaps more important, the Fed does not want to publicly admit they are deeply fearful of the impact of rapidly unwinding the balance sheet.  Chair Powell would loathe to discuss either the difficulties with unwinding the balance sheet, or the IOR’s impact on the economy in public.

The Fed needs to come clean.  The Gramm-Saving article is likely to generate greater commentary, more articles, and additional questions directed to the Fed about its IOR policy and its assessment of the impact of IOR on the economy.  I expect that the pressure will become large enough that the Fed will be forced to directly address its IOR policy to the public.

With greater Fed transparency in IOR, academic researchers should then contribute.  They can build theoretical models of monetary policy that postulate and analyze formulae linking IOR to reserve flows, lending, investment, economic growth, and capital formation.  Empirical papers should then be written that test and use these new theories, and in particular, they should measure the detriment that IOR has on financial intermediation, economic growth, and wealth formation.

As we await greater scrutiny of Fed policy, it is becoming increasingly clear to the CERF team that the Fed doesn’t know how to undo the mess it created during the financial crisis.  The need to maintain its massive balance sheet necessitates ever higher IOR.  It places the Fed in the position of following market interest rates rather than driving them, as highlighted by Gramm and Saving.  It jeopardizes the Fed’s activist mandate and renders it impotent if a severe recession were to occur tomorrow.  This is such a mess that we should assume the next economic contraction could be at least as bad as the last one that the Fed seeded.

Gramm P. and T. Saving, The Fed’s Obama-Era Hangover, The Wall Street Journal, Jan. 1, 2019 https://www.wsj.com/articles/the-feds-obama-era-hangover-11546374393?mod=mhp

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There are no surprises in our California forecast.  There aren’t any changes either.  We expect California to continue plugging along as it has for several years now.  The growth on average will be slow, but the Bay Area will do better.

We don’t see much upside potential.  That is, we would be very surprised if California’s economy did a lot better than the forecast.

We see plenty of downside potential.  New regulations and taxes will have a negative impact, but we would not expect to see an immediate or dramatic drop.  Instead, we’d expect to see California’s economy slowly lose vigor.

A national or global financial—it’s possible, leverage is high and banks are stressed worldwide, particularly in Europe—crisis would have more direct impact.  The immediate impact would be a large fiscal deficit at the state level.  The State’s response would likely be as always.  Taxes would go up.  Transfers to local governments would go down.  Debt would go up.

California’s financial situation has improved during Brown’s two terms, but California has not made the fundamental changes necessary to increase the budget’s resiliency.

Making California’s budget less susceptible to business cycles would require a major tax restructuring, reducing the reliance on a wealthy few while broadening the tax base.  It would also require that the State’s pension obligations be brought under control.

Is Sacramento likely to make the changes necessary to strengthen California’s budget?  Probably not, but now seems like an excellent time to do so.

A one-party state provides opportunity.  While the required changes would help most Californian’s, some groups would be hurt.  Those groups are part of the ruling party’s coalition, government employees and those who despise the existence of wealthy people.  The opportunity comes from the fact that these people have no place else to go.  They will not vote Republican.  The worst they could do to Democrats is sit out the election, but the party could easily retain power if that happened.

California’s Democrat Party now dominates California’s politics to such an extent that it has a unique opportunity to confront California’s long-standing issue without paying a political price.  It’s a perfect time for Governor Brown to cement a legacy.

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I have complained for years that California’s economy is not performing as it should, and it’s not working for a large part of the population, young people, minorities, less educated workers, even much of the middle class.  Those who disagree with me point out that, measured by job growth and GDP growth, California is doing better than the United States.  Therefore, California is doing great, and Bill Watkins is a cranky old hack.

Bill Watkins may be a cranky old hack, but that argument is ridiculous.

The argument that California is doing better than the U.S. and therefore doing well is based on the implicit assumption that the U.S. economy is doing well.  It’s not.

We are almost a decade into America’s weakest post-war recovery, a recovery characterized by low investment, slow economic growth, slow productivity growth, slow job growth, a falling labor force participation rate, increasing welfare rolls, and persistent high poverty rates.

It’s not like its close.  This recovery is dramatically weaker than previous recoveries.

Doing better than the weakest recovery in 70 years is not good enough for California.

At one time, the very name California was synonymous with prosperity and opportunity.  The state attracted people from throughout the world.  California was the model of the good life.

Today, California has the nation’s highest poverty rate, after consideration of housing costs.  Net domestic migration is negative, as Californians move to places like Texas and Oklahoma to find the prosperity, opportunity, and life-style they can’t find in California.  Businesses are leaving, and taking their jobs with them.  College graduates must leave to find appropriate jobs, because California creates more college graduates than jobs.  Home ownership is beyond the imagination of most young families.

California is not doing well because its policies have been hijacked by a coastal elite, which has molded policy to meet their utility functions, utility functions with no consideration for the well-being of California’s less fortunate.

California’s elite are really no different than our two presidential candidates.  Trump was born into wealth.  He was sent to the best schools.  He had every advantage.  Much of that advantage has been squandered as he followed his whims into gambling casinos, beauty pageants, reality shows, buildings, whatever attracted his attention at the time.  In his wake, he’s left failed businesses and consequently destroyed lives.  But, as they say, he’s a winner.  He’s maximized his wealth without concern for the lives of the less fortunate he’s used to maximize that wealth.

Clinton didn’t start with Trump’s wealth, but she went to the best schools, and along with her husband, has risen to the heights of power and wealth.  Like Trump, Clinton rose without concern for the lives of the less fortunate that she used to maximize her wealth and power.  From Arkansas to Washington DC and beyond, she has left a landscape that is littered with broken lives.

So it is with California’s coastal elite who dominate policy.  They have their homes and their lives in beautiful places with world-class weather and abundant amenities.  Economic growth threatens their lifestyle.  They don’t want factories or even other people’s homes marring their viewsheds.  Their attitude is that if you can’t find a job or buy a home here, well you can probably do both in Texas or Arizona.  Never mind that many people can’t afford the cost of the move.  If you live in poverty, they tell you about California’s generous safety net, ignoring the devastating impacts of a life on the dole.

Of course, California’s coastal elite who dominate policy aren’t the majority.  It seems to me that when policy is optimized for a fortunate few and actually detrimental to the interest of the majority of the population, something is seriously wrong.  Somehow, we managed to lose our way with how we select policy makers and how we make policy.

It’s not a just a California problem.  When I look at the presidential candidates and the political leaders of both parties in Congress, I see failure, failure to put competent leaders in important leadership positions.  The problem is worse in California than most other states.  Is there anywhere else in America where policy is optimized for so few at the cost to so many?

It’s difficult to believe that this is a sustainable situation.  It seems that it must reach a crisis at some point.  For California that crisis is likely to be financial, a fiscal crisis.  California’s fiscal position is fragile and volatile.  At some point, California’s under-achieving economy won’t generate the resources needed to meet California’s commitments.

California’s commitments were made based on the twin assumptions that California’s golden economy is everlasting, and there is nothing policy makers do can do to harm that economy.  Those assumptions aren’t true.  For many Californians, the state is already in crisis.  That sounds extreme, but when you can’t find a job, you have a crisis.

We need to make California work for everyone.  I’m not sure how to do that.  I am sure that we won’t make California work for everyone until we admit we have a problem.  Only then, we can start trying to find a way to choose policy makers and set up a policy infrastructure that works for everyone.

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It’s time for another presidential election.  Each candidate is promising new initiatives that will bring prosperity to Americans.  So, we’re forecasting vigorous economic growth?  No.

Our forecast is pretty much the same as it’s been for years, anemic economic growth as far as we can see.

Either Trump or Clinton will be president, but which one is president doesn’t matter for our forecast, because neither has a program that will generate the promised growth.

Trump’s economic plan is as brash, contradictory, and dishonest as he is.  He begins by assuming that countries compete economically.  This is a long-standing and popular misconception.  While not fans of Paul Krugman, we refer readers to his book Pop Internationalism for a readable, but sarcastic and arrogant, discussion of why this is not true.

Trump does offer tax, energy, and regulatory reform, which would increase our economy’s growth rate.  Those gains would be offset by his trade policies and his intention to export immigrants.  Decreasing trade and exporting workers, regardless of how the workers got here, are extraordinarily contractionary policies.  The plan is dishonest because he presents it as a unified pro-growth plan when he has advisors who have surely told him of the contradictions.

Clinton’s plan is as old, tired, and dishonest as she is.  It’s tax.  It’s spend.  It’s free stuff.  It’s more government.  It’s the same thing we’ve seen out of the Washington establishment for decades.  We all know, and she must know, it won’t bring the growth she promises.

We believe that presidents can have an impact on economic growth.  However, the president must be extraordinary and have congressional support, either because of party loyalty or political pressure.

President’s Kennedy, Reagan, and Clinton each initiated strong recoveries, recoveries that lasted for many years and saw several years of 4.0 percent or greater economic growth:

There were similarities between each of these presidents’ dominant economic policies.  Each relied on incentives and generally free-market solutions.  Kennedy cut taxes.  Reagan cut taxes and the regulatory burden.  Clinton expanded trade and changed welfare’s incentive structure.

We could have a similarly vigorous economy today, but the challenges are daunting.  It would require eliminating the negative incentives in three major pieces of legislation: Sarbanes-Oxley, The Affordable Healthcare Act, and Dodd-Frank.  It would also require rolling back the bureaucratic albatross that has built itself, increment by increment, into a formidable obstacle to economic growth.

Taxes should be reformed.  Eliminating taxes on repatriation of foreign earnings and on dividend income would be expansionary.

Monetary policy may be the biggest challenge to any president’s plan for a sustained vigorous economy.  It’s hard to see how the distortions built up by years of near-zero interest rates can be corrected without a dramatic decline in asset prices, a decline that would likely precipitate at least a short recession.  In a sense, the Fed has painted itself into a corner.

Whatever the Fed’s challenges, they are supposed to be independent of the other branches of government.  Presumably, the President’s only input is the nomination of the Chair and other board members.  We don’t believe the Fed is as independent of the political pressure as is advertised.  That said, it would take a very special Fed Chair to correct the current distortions.

Volker famously conquered inflation through a bold and controversial monetary policy, at the cost of what was until then our deepest recession.  The president would need to nominate and have confirmed another Volker.  We have no idea who that might be.

The four percent economic growth that Trump promises is possible, but it would require an extraordinary president to achieve it.  Unfortunately, our nomination process appears incapable of nominating extraordinary people.

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First, some presenters documented empirically that real interest rates since 1860 has had episodes, some of which lasted many decades, of very different behavior.  Not only has the level changed significantly in both directions, but the volatility has changed over time.  Of relevance for the current economy, it has recently been very low, oftentimes negative.

Some researchers discussed a variety of reasons why the real interest rate is so low, including the rate of time preference, fed policy, and other factors, but they did not mention the incremental productivity of equipment and structures.  This is probably because it is not intuitive that the incremental productivity of a computer, forklift, or a warehouse has fallen dramatically over time.

In Macroeconomic theory we relate real interest rates to the incremental productivity of equipment and structures via a formula.  However, when we go to the data, the latter is not observable.  To obtain a measure of the real interest rate, we must go to financial markets data and subtract inflation from a bond rate.  In thinking about a productive economy, a reasonable bond rate to deflate is the corporate bond rate.

Some researchers postulated the idea that the low real interest rate is the reason for the low performance of the US Economy.  I prefer the idea, promulgated by John Taylor, John Williams, and others, that the low real interest rate has been caused by other factors, in particular, fiscal policy uncertainty and costly regulations.  I worry that there is a wedge, partly policy driven, that has inserted itself between the after tax incremental productivity of equipment and structures, and the deflated corporate bond yield.  Another way of saying this is that while equipment and structures are themselves roughly as productive as before, but the productivity net of these recently higher costs is lower because the costs have risen substantially.

With this idea, we see that there are other factors, fiscal policy uncertainty and regulations, that have caused both slow economic growth as well as historically low real interest rates.  It is at least a possible that long-term trends in the regulatory environment have partly contributed to the long-term evolution of the real interest rates since the 1860s.

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One of the Big Five banks is BofA, and I am one of their customers. It is convenient for me to walk up to a BofA ATM machine in Michigan, Florida, Oklahoma, or anywhere in the U.S. and withdraw cash without paying fees.

It is also convenient for regulators at the Fed, the FDIC, and the Treasury to maintain surveillance over just 50 banks rather than say, 500.

The justification for the consolidation in late 2008 went something like this: size helps offset the bad assets on the books and we (the Federal government) will watch over these institutions very carefully now.

I strongly object to current U.S. banking policy. This is despite the convenience to me and despite the convenience to the regulators, although these are trivial. Policy should not be justified by convenience.

Size matters. The risks that $7 trillion in assets pose to a $17 trillion dollar economy are massive. A loss of “just” $1 trillion in 2015 would be six percent of 2014 GDP. One trillion dollars is double the contraction in GDP from 2008 Q3 to 2009 Q2.

Further, the trend is in the wrong direction. This, interestingly, is despite one of the intentions of the Dodd-Frank legislation. The top five’s share of total U.S. banking system assets has grown impressively, growing in every year but one since 1990. In 1990, they held less than ten percent of total assets, and by 2014, they held 44 percent. Soon, the top five banks will be fifty percent of GDP.

Returning to the carefulness of the regulation, just because the government is more involved with managing these large banks does not necessarily mean that the economy is safer. There is often a revolving door between regulatory agencies and those they regulate. This creates the wrong incentives for protecting the economy, and these incentives worsen as the large banks get larger.

We should change policy to begin the process of breaking up these banks. It will not be easy, and it will take time, so we should get started sooner rather than later.

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Liftoff has market watchers glued to their monitors for a number of important economic reasons. Because the rate is related to other longer-term interest rates through the Term Structure, and the longer-term rates are used to discount cash flows, this affects net present value (NPV) calculations, making more investment projects appear profitable. Aside from new projects, lower corporate bond rates bring down a firm’s borrowing costs, raising their net income.

The argument for low rates in late 2008/early 2009 was a good one. We had faced a serious financial crises and were in the middle of a serious recession, one that appeared at the time to be the second greatest economic contraction since 1929. Many financial entities faced a liquidity crunch, where short-term credit had vanished. Firms shelved positive NPV projects. Households were upside down on their homes. Because the housing market was so decimated the lower mortgage rates were thought to be needed to help resurrect home sales activity and promote refinancing which in some cases could help a household remain as a homeowner.

The Fed’s dual mandate of price stability and economic growth, argue in a conventional way against raising rates at this time. Historically, rates were raised as a way to cool down an economy with rising inflation or dropped as a way to spur economic growth. However, inflation and economic growth continue remain low compared with postwar U.S. history.

Despite this, I think the Fed should immediately begin the process of raising rates toward historically normal levels. The abnormally low interest rates were probably justified by the double feature of a financial crises and a large economic contraction back in late 2008/early 2009, but they do not have that justification now. The canonical Taylor rule formula as published by FRED at the St. Louis District Federal Reserve bank calls for a Federal Funds Target rate of 2.44 percent.

It is safe to say that financial markets, consumption activity, and savings and investment decisions are being distorted by the low interest rates. As one example, household balance sheet rebuilding was and still is important for the long-term economic health of the U.S. A higher return to savings would aid and incentivize this activity.

The economy should be able to grow with interest rates at normal levels. If it cannot, then it needs to relearn this ability. If this process ends up taking some time, we should begin it sooner rather than later. An imminent financial crisis does not seem to be a high probability event at this time. However, if one did happen now, being at the zero lower bound would be an inconvenient reality indeed.

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Progressive taxes on capital income imply that the equilibrium capital stock level will fall. In fact, capital income taxes can be high enough such that capital accumulation is significantly diminished.

This capital stock level is a form of wealth. This is a useful kind of wealth, often it can be used to create more income or more wealth. In some cases it can be consumed. Think of an Ipad, a modern example of capital. An Ipad can be used for work or play, i.e. it can be used to create either income or wealth, or it can be used for leisure, i.e., consumption. Macroeconomic wealth is like a savings account, if it is too small then prospects in an uncertain world are not as good. It can be too large too, but this is a rare problem in nations these days.

It is not automatic that countries accumulate capital. Many countries, there are numerous examples from all over the world, have not done this or cannot do it despite generous natural resource endowments. This is the topic of research in Development Economics and in Economic Growth theory. We believe that institutions are important to the accumulation of capital, especially the rule of law, with an open and fair legal system and contract enforcement. But there appears to be more to it, hence there is ongoing research.

Given that capital and wealth accumulation are not foregone conclusions for many countries, and given that the United States has been a highly impressive capital accumulation machine, I dub the United States economy the Golden Goose. Obviously, I am using the United States as an example, because there have been other economies that have been capital accumulators. The original Golden Goose idea was for something truly rare. However, I stick to calling the United States the Golden Goose, since there are a lot of important factors that must be in place to enable capital accumulation, and there are a depressingly large number of countries that have not found a growth combination.

A second central Macro-theoretical concept is that a larger government has implications. A larger government means greater taxes. Government debt is not a long term option, because at some point, that debt must be paid by taxes. However, this is frequently a generation against generation issue, as current public debt is usually not paid through current taxation, but rather, by future taxation.

There are two new ideas that have gathered some momentum in United States politics recently. One is that the size of the government should be larger, and the second is that taxation should be more progressive.

There are a couple of ways that taxation can be made more progressive. The plainest way is to raise the top marginal income tax rate on a type of income. However, taxes can be shifted from labor income taxes to capital income taxes. This makes taxation more progressive because capital income tends to accrue to wealthier households. This second way of making taxation more progressive has recently gained political momentum.

While taxation cannot be perfectly flat, the important point from theory and experience is that taxes can be too progressive.

I would like policy makers to understand the macroeconomic impacts of implementing these new ideas in the United States. A larger government would imply greater levels of future taxation. Greater levels of future taxation, combined with a more progressive tax system, would imply a noticeably lower level of equilibrium capital in the United States. In other words, it is possible to kill the Golden Goose.

Capital and wealth accumulation should be understood by those in favor of government as essential, something to foster. Why? Private economic activity is needed to support any benevolent government, regardless of size. It provides the funds the government needs to operate.

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