On Sept. 17, less than a month before he was awarded the Nobel Memorial Prize for Economic Theory, Yale Professor James Tobin appeared before the Progressive House Staff Group on Capitol Hill for a private discussion of President Reagan's economic program. The group invited Washington Post columnist Hobart Rowen to sit in. With Tobin's permission, Rowen taped the hour-long session, in which Tobin gave his candid and critical views on Reagan's tax, budget, and monetary policies. Tobin also charged that Fed Chairman Paul Volcker is deliberately risking a recession, and that the administration has shirked the political responsibility for the Fed's tactics, which it has endorsed. He also had some sharp words for the way Wall Street has orchestrated its views. Extracts from Tobin's remarks follow:
MONETARY POLICY AND HIGH INTEREST RATES
As you can see, the president got his way on both the tax cuts and budget cuts, but following the euphoria , sober second thoughts have arisen, or maybe sober first thoughts that weren't expressed widely enough beforehand, surfaced and things are sort of in a panic both in New York and Washington. . . . The Federal Reserve monetary policy is precisely what the administration wanted the Federal Reserve to do, in fact ordered them to do, and it's not any surprise what has happened. . . .
It was apparent last winter, when the program was first set forth, that the monetary targets that the Federal Reserve was committed to--with the strong urging endorsement of the administration--were very stingy targets, and they involved a schedule of reduction in the growth of money for the next five years. . . .
It was also apparent that . . . the stingy monetary targets were bound to produce extraordinarily high interest rates, and those high interest rates would turn out to be an almost insurmountable hurdle to the achievement of the recovery in output and employment, which the administration was at the same time projecting.
And that was true even if you accepted their rather optimistic views on how fast the inflation rate would subside, and even more true if you took the more realistic view of that. Well, they went ahead with the tax and budget program. . . .
Now I must say that if you took the budget cuts and the tax cuts at the face value, as they were proposed in the economic recovery program document presented by the administration last spring, the tax cuts did not appear to be really excessive in a macroeconomic sense. . . .
BUDGET DEFICIT FEARS
Since then what has happened to change that outlook? . . . There are legitimate reasons for worrying about the budgetary outlook, as Wall Street is doing and as the president and his advisers are doing. . . . If you thought that the administration and the Congress would be unable to come up with subsequent budget cuts as were included in the program but not specified, then the tax cuts involved would be bigger than the budget cuts, and that would be a legitimate cause for concern. . . .
On the other hand, some of the concern seems to be triggered by the realization that the economy will not be as strong as the administration forecast. Therefore, the revenues collected from the economy will not be as large. And therefore, it will be harder to realize the administration's hope , which involves--as it does in every administration--a balanced budget in the final year of the term of the president.
That, I don't think, is a legitimate reason either for financial markets to get upset in the way they have or for the Congress to tighten the budget. If that happens, it leaves the economy weaker than it was thought to be by the administration that made the forecast. And it's a perverse response to that kind of information to make budget policy tighter as well. That's a chasing-your-tail strategy such as Mr. Hoover tried in the 1930s. . . .
IMPACT OF INTEREST RATES ON FEDERAL DEBT
There is another major reason for which the budget outlook has deteriorated relative to the administration's initial forecasts. High interest rates mean, among other things, that the public debt interest is going to be higher in the budget. But the high interest rates are a deflationary factor in themselves, and so it's sort of kicking the economy twice--you kick it once with the high interest rates and you kick it again because the high interest rates show up in the budget as more expenditures. . . .
What the markets are worrying about is crowding out, whether the markets will swallow the large issues of government securities, which they foresee because of the deficits. But the fact is that if you look at the size of the debt as it would be at the end of 1984 under the Congressional Budget Office forecasts of the budget, the size of the debt will be no bigger relative to GNP than it has been--namely about 22 to 23 percent--and it was a lot higher than that in the 1960s and the 1950s. . . .
So I think that some of the concern about this is overblown and exaggerated. There is a legitimate concern. It certainly is reasonable to be concerned about the high interest rates, not simply because of inflation but because current interest rates after you subtract the rate of inflation, that real interest rates are higher than they've been in this country since the Great Depression of the 1930s. And it's very hard to foresee that the economy can stand up under those kinds of real interest rates. When you're paying prime rates of 20 percent for business borrowing and the inflation rate may be 8 or 9 percent--that's 11 percent, 12 percent real interest rate, you don't make money that way. . . .
So that's something on which everybody agrees, that the interest rates are terribly high and they ought to come down. The question is how.
VOLCKER'S THATCHER-LIKE POLICY
There are several ways that they could come down. One way in which they can come down is that we will have a recession, or we'll have at best a stagnant economy on the edge of a recession with intermittent dips in the economy, but with unemployment 7 1/2 or 8 or more percent for a number of years. . . .
I think, in a sense, that people do not sufficiently appreciate that that is the aim of Federal Reserve policy. . . . If you read or heard what Paul Volcker has said during the time he's been chairman of the board, before the Reagan administration came in and after it came in, you would know that he's embarked upon a kind of single-minded and single-institution campaign to bring the rate of inflation in this country down. And the only way he can do it, the only way the Federal Reserve can do it, is to be stingy about money stock and accept whatever high interest rates come about, and accept whatever kind of damage this does to the real economy in terms of unemployment, low production, recession, low investment, and so on in the hope that in time, enough people will be unemployed, enough union leaders will be desperate to protect the jobs of their members, enough businessmen will be like Chrysler--desperate for selling something--that they will begin to slow down the rates of wage increase and price increase in the industrial sector of the economy, which are the core of our inflation.
. . . .Then you can break the inflation--eventually--but painfully and with considerable economic damage. . . . That's basically the strategy. Now, that's the strategy of Mrs. Thatcher in England. You can observe what's going on there and see how much damage it does and see also that it does slowly work and you do bring down the inflation. There is a big difference between Mrs. Thatcher's policy in England and the similar policy in the United States because in England it's Mrs. Thatcher that headed the government and in the United States it's only Paul Volcker who expresses this policy.
It's one thing for Mrs. Thatcher to get up on national television and say, "we don't care what happens to the unemployed. We don't care what happens to the real economy in this country. We're going to stick by our guns. If you choose to waste the money we give you in inflation, too bad. There just won't be jobs for you, and that's not our fault. We told you that's the way it was going to be." If Paul Volcker tells you that in his dignified and low-key way, who hears it? I hear it because I read what Paul Volcker has to say because I have a professional interest in it. Maybe a few of you do that and all the people in the bond market and the money market also hear it . But that's not getting the message to the heads of unions in Des Moines, St. Louis and San Diego. And that you'd only get it, if at all, by the president saying: "That's our strategy". The president had not said that. Instead , he said: "We'll end this inflation because the Federal Reserve will take care of that. But meanwhile we'll have more jobs and a lovely growth in the economy." So we're following a Thatcher policy without any of these damages, which a powerful political endorsement of the policy and explanation of the policy might give us in terms of speeding up the response.
WHAT THE FINANCIAL MARKETS WANT
Another way which interest rates could go down--and this is the way the financial markets would like it to happen--is for fiscal policy to be made a lot tighter, more budget cuts . . . achievement of the balanced budget in 1984. Then there won't be all those government securities coming into the market and crowding out private borrowers.
And they don't really care very much about what happens to the economy in the meanwhile. If the result of that policy is merely to add restrictive fiscal measures to Paul Volcker's restrictive monetary policy, then that adds to the pressure for low interest rates, but it also adds to the pressure for a recession. . . . So what they financial markets want to do is to put the blame for high interest rates onto the budget.
And that's what the administration is going to do now. . . . For nine months of the year, or eight months of the year, you put on your supply-side hat and you go for these tax cuts and forget or underplay the budgetary consequences and all the stuff I've just been talking about. So you don't have to worry about that. And I must say the business and financial community seeing those goodies in their tax bill also mute their criticisms of the financial policy, because they want to get the tax bill. It's not true of everybody, but it's true of a lot of them .
Then you get the tax bill, and it's signed, sealed and delivered and now you put on your budget-balancing hat and you say, "God, this is awful. Congress has got to shape up and give us the budget cuts to make our inconsistent forecasts of last spring come true." And that's a recipe for getting further cuts in civilian, social programs in the budget on the ground that they are necessitated by financial policy, and for avoiding the possibility that this will be done by giving up the tax cuts that are so pleasant for everybody both politically and personally.
THE BETTER ROUIE: ADJUST THE POLICY MIX
Now, there's another way to go, I think. I personally agree that the mixture of monetary and fiscal policy is not a good one. That is, we have too tight a monetary policy and too easy fiscal policy. So I would like to see, I would have liked to have seen, a mixture that involved an easier monetary policy at the same time as having a smaller tax cut than we did have in the bill that was passed. And I would still like to see a shift toward that kind of mixture of policy. It would result in lower interest rates than we have now and than we are about to have over the next few years. . . .
The question is whether the Congress should do the only "giving" in getting to that mix of policy. The difference between what I said and what the guys in Wall Street are saying and what the administration is saying now, is that they want a tighter fiscal policy, but they don't want an easier monetary policy. . . . If I were a member of Congress, I wouldn't give the tighter fiscal policy without getting an assurance that it would be coordinated with an easier monetary policy. So we'd get the benefit of it in lower interest rates without sacrificing the overall progress of the economy in Paul Volcker's Thatcher-like austerity. Even then, I would still like to combine the policy with a wage-price policy, because I don't think we'd get tolerable progress on inflation without doing that.