THE FIRST RESPONSE to the Reagan tax strategy, it turns out, is not economic euphoria but, as the administration now acknowledges, a recession. It's hardly unexpected, but it's sad. Once again it's demonstrated that within the framework of American politics as it now stands there's no way to pull down the inflation rate without more unemployment, bankruptcies and erosion of living standards. Theoretically, it could be done through voluntary restraints on wage and price increases. But Americans don't seem to like the idea.
What's to be done now? The term "recession" is itself seductive. It suggests that the trouble is merely cyclical. It hints that, as in the other cycles over the past generation, the decline will presently cure itself with a little of the customary reflationary help from the government, in the form of lower interest rates and more federal spending.
That's been the remedy, increasingly explicitly, ever since World War II. The quickest response has generally come in the sectors most sensitive to interest rates--cars and houses. By the repeated use of this remedy over many years, the country has created a standard of normal growth that depends on high rates of production of automobiles and housing--which, in turn, seem increasingly to depend on credit terms that are inflationary.
But this time it's not clear that the federal government could lower interest rates much, even if everyone--including Paul Volcker and the Federal Reserve Board--wanted to. Recent experience argues that any sustained expansion of the money supply is taken by lenders as a signal of future inflation, rapidly leading to near-panic in the financial markets and interest rates higher than ever.
You have been watching the pain and confusion through which the federal government is going as it struggles to reduce its budget deficits--that is, its borrowing requirements. It's important to note that much the same thing is going on in some private households, most businesses and nearly all state and local governments. When interest rates were below inflation rates, it paid people to buy on credit. A lot of people made money that way in the 1970s, to the enormous cost of the lenders. But now, with interest much higher than the inflation rate, the rules are suddenly reversed. A lot of businesses, running efficiently under the previous regimen, now discover that, under the new rules, they have become desperately unprofitable.
So far the recession has been mild. But it looks as though this time there won't be the traditional triumphant surge of recovery, led by accelerating production of automobiles and housing. This time, it looks as though a profound restructuring of the economy may be getting under way, for reasons the government can't fully control. The cost, if that turns out to be the case, will be carried above all by the credit-sensitive enterprises and the people who work for them.