Has economic policy turned upside down?
Unemployment, already 8.9 percent of the work force at the end of last year, is likely to be higher this year than in any other since 1941, while inflation is clearly coming down from the peaks of the Carter years. What the economy needs, you might think, is stimulus, pump-priming.
Yet the Congress returning to town this week will be asked by President Reagan to act in the opposite way and make further deep cuts in domestic spending in fiscal 1983, which begins Oct. 1.
These cuts are likely to hit particularly hard at social programs that have been the traditional balm of the poor and unemployed in recessions. Policy-makers also are considering higher taxes.
It is, on the face of it, an extraordinary response to obvious economic weakness in an election year. But underneath, the Reagan budget policy may, in these broad economic terms, be less restrictive than it seems.
One main reason is that last year was extraordinary, too. Congress voted the largest tax cut in history, worth almost $750 billion between now and 1986. It also approved the beginning of a defense buildup which will add more than $20 billion to the military budget this year, fiscal 1982, and almost $35 billion next year if Reagan has his way.
These past acts mean that without new spending cuts or tax increases, fiscal policy in 1983 and 1984 will be strongly expansionary; even with them it will be somewhat so. The shift toward stimulus will get under way in earnest with this summer's scheduled individual income tax cuts.
But why should the president and Congress be moving to offset that stimulus in an economy where idle factories and poor sales outlooks mean that businessmen are not investing--despite generous new tax incentives--and the job market is shrinking?
Persistent high interest rates are the reason.
There has been a basic contradiction in administration economic policy from the outset. Budget policy was made expansive with the 1981 tax cut and defense spending increases--but money policy as administered by the Federal Reserve Board was kept restrictive.
The result of the contradictory policies, the one feeding demand for funds, the other constricting their supply, has been high interest rates. These have in turn helped bring on the recession.
It is to reduce these rates and help the economy expand that the president's advisers are now urging limited budget restraint. Without spending cuts and some tax increase, the likely deficits in fiscal 1983 and 1984 will be quite large; it is the prospect of these large future federal credit demands that is helping keep long-term rates high, administration economists say they believe.
Yet these spending cuts and tax increases, whatever they do to long-term interest rates, will also have another effect: to reduce overall spending power in the economy, dampening total demand. They will thus also serve to exacerbate the recession they are intended to overcome.
The point in a way is that money policy is dominant; fiscal policy is in a box. The administration and Congress can now fine-tune the budget all they want but cannot greatly expand the economy while money remains tight. By this view, even if budget policy is slightly upside down, it may not decisively matter.
Almost no one is suggesting that tax increases should take effect in this recession year, although the president wants new spending cuts to begin in October. But restrictive policy measures--including tax increases--should be put in place to narrow the out-year deficits, according to those who are seeking to combat high interest rates.
After staying at record levels last summer for much longer than expected, interest rates eventually came down in the fall with the onset of recession. But they have now taken experts by surprise again and started back up from levels that were already very high for this stage of the business cycle.
The president already has begun to chafe under the Fed's tight money rule. But he has not yet made clear whether he wants more or less money growth. Nor has supplysider Rep. Jack Kemp (R-N. Y.) who has called for the resignation of Fed chairman Paul Volcker and for lower interest rates but has declared himself against easy money.
Last week the president and Treasury Secretary Donald T. Regan castigated the Fed for letting the money supply grow too rapidly at the end of last year and the beginning of this year. It was this upsurge which has sent interest rates climbing, they say.
But Regan also has complained that money growth was too slow last year, and warned that there must be "sufficient" money expansion this year to allow the economy to recover strongly.
Most experts believe that this would require a substantial relaxation of money policy. The president may yet argue for this. It is high interest rates that Reagan really dislikes, and with the Fed and its money policy as a handy scapegoat he is likely to blame uncomfortably high rates on whatever it is that is happening to the money supply at any given time, some observers say.
This ambivalence over money policy probably reflects a fundamental uncertainty over the goal of economic policy: whether the fight against inflation should take precedence over holding down unemployment.
Last year Reagan promised Congress that it could have both more growth and less inflation. This year it is clear it cannot, or at least not with present policies, any more than the Fed can make money grow both more slowly and more quickly.
The administration is proud of its success in bringing down inflation. But this success has a price: it is the recession that is now largely responsible for holding down wage and price increases, most experts say they believe.
The high interest rates which precipitated the recession were the result of tight money, not easy money and--the spurt in money growth in the last two to three months notwithstanding--it is likely to be tight money that slows or stalls recovery .
Bringing fiscal policy into line with this tight money policy will not lead to economic growth and a decline in unemployment, but merely to a more balanced and concerted fight against inflation of the traditional Republican kind.