At an unusual seminar last week sponsored by the American Enterprise Institute, all three members of the Council of Economic Advisers, along with the undersecretary of Treasury for tax and economic affairs, Norman Ture, discussed the Reagan administration's economic policies, especially the issue of budget deficits. Some of the remarks of CEA Chairman Murray Weidenbaum and members William Niskanen and Jerry Jordon--that deficits are not necessarily bad for the economy--challenged the Republican orthodoxy. The statements raised hackles in Congress and at the White House where official spokesmen reiterated that President Reagan is very much concerned about deficits, which internal administration estimates now place at more than $100 billion for 1982 and, in the absence of spending cuts or tax increases, at more than $150 billion in 1983 and $160 billion in 1984.
Several AEI economists, including former CEA chairman Herbert Stein, former member William Fellner and Rudy Penner, former chief economist for the Office of Management and Budget, questioned the administration officials closely and disagreed with some of what the Reagan advisers had to say. Other economists and members of the press were in the audience.
Here are some excerpts from a transcript of the seminar:
Ture: . . . I think there can be no question about the fact that the Federal Reserve and the people in the administration are of a single mind about the desirability of restricting the growth of monetary aggregates to rates and proportions that are consistent with a continually declining rate of increase in the overall level of prices.
What should we look for as the consequences of a successful pursuit of that policy? . . . The old conventional wisdom . . . says if you restrict the rate of increase in the price level you must, necessarily, reduce employment and therefore total output in real terms as well. That is a judgment which I think is not well-founded either in analysis or in the empirical record, and it is a line of reasoning which, I think, has no part at all in the framing out of the economic policy and strategies of this administration . . .
Fellner: . . . You'd expect that there will be lags in the effectiveness of anti-inflation policy because cost trends do not adjust instantaneously. . . and because there is a credibility problem. The credibility, I think, is being gained now by the Fed and I think that people take their posture very much more seriously than they did in the beginning. . . .There is a dilemma of long-term cost agreements which is likely to lead to some slowing and indeed to carry this system through a recession before it really gets on a path of healthy growth . . . and I would expect through a slower recovery than that which we would have if we were willing to accept the rekindling of inflation . . .
Weidenbaum: . . . A traditional starting point in the budget process is the selection of the specific economic assumptions underlying the budget. This activity encompasses far more . . . than projecting the future performance of the economy. It also involves choosing, or at least assuming or projecting, future monetary policy, regulatory policy, the international environment, fiscal policy, and the economy's response to all that . . .
Quite clearly, the faster the economy is expected to grow in the future, the higher, in general, will revenue collections be, and the lower will be outlays for unemployment compensation, welfare, food stamps, and other cyclically sensitive programs, the traditional built-in stabilizers.
But to some extent, good economic news is not necessarily good budget news. Thus, more progress in lowering the rate of inflation means less rapid growth in the tax base . . . and less revenues and a larger deficit than otherwise . . .
The heart of budget-making, of course, is a choice of expenditure priorities and of spending totals . . .
At times, the tax policy choices can be among the most important decisions in the budget cycle . . . However, . . . I believe the basic tax decisions are behind us. I have in mind, of course, the Economic Recovery Tax Act of 1981 which constitutes those basic tax decisions, and which the Reagan administration is determined to carry through . . .
The fourth schedule or menu of budget choices is . . . fiscal policy, determining the magnitude of the overall surplus or deficit that the administration aims to achieve.
. . . during a time of recession, such as now, a large deficit will not be crowding out the rather modest funding needs of business and consumers.
But in fiscal 1983 and beyond, when we anticipate a period of rapid growth in the economy, a steady and substantial reduction in the budget deficit will be very much in order. Substantial deficits cannot be viewed with indifference. They represent a call on private saving and foreign capital inflows that would otherwise be available to the private sector. They will make the Federal Reserve's job of monetary restraint more difficult, but not impossible. They will give rise to concerns that the federal government cannot get its fiscal house in order, that budgetary discipline is an impossible goal, that inflationary pressures are bound to increase.
I, for one, do not share those fears. The most fundamental measures of control over the federal government are those which relate government spending and taxes to the overall size of the economy. In this respect, the administration's projected budget outlay and revenue targets remain reassuring. Their size, as a percentage of GNP, will continue to decline between now and 1984. Likely prospective budget deficits, while they will be sizeable, can be financed without undue pressure on financial markets or on the Fed.
Indeed, our budget deficits represent a much smaller share of our GNP . . . than is the case in periods in the past or for many other industrialized nations with lower inflation rates. . . .
Stein: Thank you very much, Murray, for that reassuring explanation of the $160 billion deficit. (laughter)
Penner: Well, to us sports fans there's a certain irony in the fact that the all-time record deficit is $66 billion in 1976, set by Gerald Ford, a conservative Republican, and it will be broken by yet another conservative Republican . . .
Clearly, the administration is making it harder and harder to avoid a whole string of record breakers . . . But unless you consider very major tax increases, the only way to make significant progress in reducing the deficit is, in effect, to really slash the non-security, non-defense, non-interest part of the government, really below levels that even this free market economist would like to see. . .
I am disturbed by the huge deficit that one sees in '83 and '84 . . . I don't worry a great deal about the '82 deficit . . . But if we retain the kind of assumptions with which we're analyzing these things today, the real question then becomes which of these sacrosanct areas that I'm talking about will be defiled. Will it be defense? Will it be social security? Will it be tax policy?
. . . the bottom line, it seems to me, is that if there are to be major reductions in the '83 and '84 deficits, there must be some rather significant tax increases compared to those we have enacted in current law.
Niskanen: We face the prospect of what will be--what are now perceived to be very large deficits for some years. And I think it's important for us to think about how we should think about those deficits.
The prevailing approach toward them has been to try to address the effects of deficits on general economic activity, on inflation, on money growth, on interest rates, and so forth.
An alternative approach that I want to elaborate on is to look at the deficit as if it were the borrowing by a family or by a firm, and to look at the consequences of that deficit in combination with other things that the government is doing on, basically, on the net worth position of that organization . . . . . .
The simple relationship between deficit and inflation is as close to being empty as can be perceived. A wide range of inflation rates are consistent with roughly the same deficits, and vice versa.
Controlling for the other obvious conditions that effect inflation rates in a more complex model, you also find no effect of deficits themselves on the inflation rate . . . .
So we shouldn't worry about a direct relationship between deficits and inflation. It just is not in the data, it isn't consistent with at least monetary theory, and it is not something in which I think there is any special reason to be concerned.
The more plausible reason to be concerned about the deficits is that in the popular language now, the deficits put pressure on the Fed to monetize the deficit . . .
There turns out, also, to be a relatively loose relationship between how much new debt the Treasury offers and how much existing debt the Federal Reserve Board buys. Now, this relationship is the simple relationship between money growth and the deficit. And you do find a small but insignificant positive relationship in the simple relation between money growth and the deficit . . .
The most important conclusion, however, is that there is no necessary relationship between the deficit and money growth . . .
Let me address the third more recent concern about the deficit, and that is that the presumption that deficits crowd out private investments, and they do that by increasing interest rates. That's a wholly plausible conjecture. It just turns out not to be consistent with the evidence.
The simple relationship between deficits and interest rates are negative. In other words, the simple relationship, higher deficits are associated with lower interest rates. The reason for that is fairly obvious, is that you typically run your highest relative deficits in recession years when interest rates are low. . . .
You have to run something like a $60 billion dollar deficit in order to keep the government's net worth from increasing . . . because there's over $660 billion of government securities held by private investors. He means that an inflation rate of 8 percent or so would, in a year, reduce the real value of that outstanding debt by more than $50 billion, and hence add to the net worth of the federal government.
In addition, if any deficit above that is used to finance increases in the capital stock of the federal government, then that itself does not reduce the net worth of the federal government . . . .
The implication of that is that we should be prepared, I believe, to accept a deficit of in the order of $60 billion plus the increase in the capital stock of the federal government during the relevant planning horizon.
Now, that has to be evaluated, of course, in terms of the relevant alternatives. The two alternatives which come most quickly to mind for any number of people are to re-inflate, or to substantially add to taxes, again. Without minimizing the legitimate reasons to be concenned about the deficit, I would regard either of those two options as much less preferable . . .
And if we want to reduce the deficit beyond these parameters that I am suggesting, I think that it ought to be focused, if not exclusively, dominantly on continued spending control.
I've come around a bit on these views. I must acknowledge that my change in views on the deficit preceded my position on the Council, so I would not want there to be any basis for a charge that somehow I've learned to rationalize big deficits in the last few months.
Questioner: . . . The entire campaign and initial game plan of the administration rests on the assumption that deficits are the villain, and in fact, they feed into the inflation rate, the crowding out, and the only thing we can do really and center on is reducing the size of the inflation. . . How can you now change the particular atmosphere the administration created and restore credibility?
Niskanen: . . . It is now recognized that some of the expected effects of the Reagan economic program are inconsistent and that something has to give. I've gone back over and checked campaign statements, and most importantly the February 18th statement of the president's program for economic recovery for guidance because probably more so than any president in years, Mr. Reagan takes his campaign statement seriously.
Now, the focus of almost all of that material was on what has come to be the four elements of the Reagan economic program. The deficit was represented in the February 18th statement as an expected effect if we get all of our spending cuts and Congress does not increase our tax cuts. It was not billed, at least in that statement, as an important feature of the program . . .
Weidenbaum: I'd like to offer, hopefully, some insight into the continuing concern, at least in some quarters, about deficits. I think the underlying concern is a serious matter, and it is, and it's been alluded to earlier in these discussions, to control the growth of government.
And we measure that most conveniently by outlays. Surely the pressure for government spending growth is omnipresent. What is the counter pressure? In the legislative process it certainly isn't something as esoteric as the percentage of the GNP or even the aggregate growth rates of spending, nominal or real, but, and here we're led back to the concern over deficits.
And I think we need to keep in mind the underlying relationship between what seems to the ephemeral concern over deficits and the underlying long-term concern about slowing down the growth of government, especially, federal government . . .
Stein: But aren't you worried that the whole trend of this discussion is reducing the inhibitions about running deficits, and therefore, weakening this restraining force against government spending.
Weidenbaum: Maybe that is why I made my comment.
Stein: Well, that's a good reason to make the comment but something more needs to be said then. That is, you need to reestablish some defensible reason for not having deficits. That is, if you've now told us that they don't cause inflation, they don't crowd out--and you see it is not sufficient, as we know, for a group of economists to sit around and say, "Well, a deficit of a hundred billion dollars doesn't have these adverse effects," because you're dealing with a bunch of congressmen out there, and if they say a hundred billion, well, why not 300 . . .
So I think that's the problem you have, and I don't think it's impossible, but I just hope that you will devote yourself to describing some other limit . . .
Weidenbaum: Well, in the qualitative way, I've tried to do that . . . I've suggested that a useful approach is to think as the economy expands in fiscal '83, fiscal '84 to successively and significantly reduce that amount of deficit spending . . .
Jordan: Herby, I think there is a defensible approach which will be a little hard to explain because we have not kept regular series on it and that is to say we do not want to reduce the real net worth of the federal government.
And there is a specific deficit number that comes out of that that is also a function of what the money is spent for, whether the money is spent for capital improvements or for transfers and current consumption.
If we do not reduce the real net worth of the federal government, we are not increasing the burden on future generations, and I think that the fundamental issue of the deficit is the time distribution of taxes and spending, because the deficit either has to be paid for by higher future taxes or by lower future spending, and that, I think, is the fundamental issue and that is primarily a question of intergenerational equity, I think not primarily a question of economics.
I think that a rule of no change or no reductions in the real net worth of the federal government would be a rule that we could stick with.