THE AMERICAN ECONOMY now seems to be moving toward another decline, the second phase of the double-dip recession. By all present evidence it will be mild, nothing like last spring's severe downward pitch. It doesn't look as though it will last long. By summer, business should be expanding again. Then what?
That is the delicate moment toward which policy now needs to be aimed. The prospect is not entirely reassuring. One well-informed and unsentimental view is offered by the economists at Goldman Sachs, the investment banking house. Inflation, and the probability of more to come, will still be high when business begins to pick up at mid-year. As more people bid for credit, and as lenders try to protect themselves from the dollar's decline, interest rates will move sharply upward. Once again, high interest rates will check economic expansion -- and, according to this view, there will be another slowdown late in the year. The Goldman Sachs forecasts are deservedly influential, and this one makes the important point that interest rates are now setting the limits to the country's economic performance.
The Federal Reserve Board has now undertaken, with unprecedented determination, to do battle with inflation. This time, the people in the financial markets have truly begun to believe that the Federal Reserve won't let go. Paul Volcker, the Chairman of the Federal Reserve, amiably explains that he and his board aren't setting the interest rates. They are only trying to control the growth of credit. Interest rates are the prices at which people choose to buy and sell that credit.
Mr. Volcker has made it pretty clear that he does not intend to accommodate a rising federal deficit. If the government borrows more, there will be less credit for everyone else -- and at higher interest rates. Mr. Volcker's view is that any cut in federal taxes ought to be accompanied by simultaneous cuts in federal spending.
That's a decision of basic strategy that Mr. Reagan is going to have to make very soon -- perhaps in his speech tonight, certainly before the end of the month. People who want a big, fast tax cut don't like the idea of a commitment to tie it to the slow and complex politics of major budget revisions. But if Mr. Reagan decides to press ahead with the tax bill first and let the ugly budget questions come later, he will run enormous risks.
The economy would begin to expand against a very tight money supply, sending interest rates up faster, and probably farther, than last time. Worse, inflationary expectations would spread like chicken pox in kindergarten. Fairly or not, the new administration's willingness to take on the budget is now widely regarded as the test of its ability to make serious decision and exercise real control. If it steps around the budget in its hurry to a tax bill, a great many people will interpret that as simple evasion of an unpleasant necessity.
Perhaps the country isn't in a double-dip recession after all. Perhaps it's caught in a cyclical pattern of brief expansions, setting of recurrent credit crises that, in turn, will keep throwing the economy repeatedly back into short declines. The United States has now been through two of these episodes, about 10 months apart, with a third coming into sight ahead. It will take more than a tax cut alone to break this self-perpetuating cycle.