THIS WEEK IS probably going to mark a turning point of some considerable significance in economic policy--although in what direction it will turn, no one can yet say. The economic theories that President Reagan brought to Washington have now been discredited by events. Orthodox economics has, sadly, been confirmed, and all the original hard choices are still there to be made. There's little sign of any new initiative from the administration.
Increasingly, the making of policy is being left to the other players in the game--the Federal Reserve Board, Congress, the banks and the industrial corporations--to try to work around the intractable circumstances that Mr. Reagan and his too-large tax cut have created. There is rising alarm among businesses at the prospect of continued high interest rates. There's many a well-managed, productive company that is simply not viable when the banks lend at 10 percentage points above the inflation rate. Inflation has to be slowly pulled down. But how much damage to the country's industrial structure is justified by the present progress?
The week's events began yesterday, when the Federal Reserve Board lowered the discount rate-- the rate at which it lends to commercial banks--by half a point. That is a statement of policy, intended to signal a measured and careful push toward somewhat lower rates. Today, the chairman of the Federal Reserve, Paul Volcker, will deliver his mid-year appraisal before the Senate Banking Committee. The Federal Reserve cannot go far in this direction without inciting new fears of another wave of inflation. But the board has evidently decided that the dangers of a deepening recession now outweigh the danger of renewed inflation.
On the subject of the recession, the Commerce Department will publish on Wednesday the gross national product--the broadest measure of economic activity--for the second quarter of the year. A month ago, there was a lot of good cheer coming out of the administration to the effect that the recession had clearly ended and the quarter's GNP would show a recovery under way. The preliminary figures for June have apparently not borne out that optimism. The thought of the coming income tax cut seems to have had remarkably little impact on spending. If the GNP numbers on Wednesday suggest that the recession is continuing, a heavy shadow falls over the outlook for the rest of the year.
On Friday, the consumer price index for June will appear. The CPI showed an extraordinarily low rate of inflation through the first four months of the year, and was frequently cited by the administration. But those low figures were misleading, as the May CPI suggested. Inflation is declining, but much more slowly than those earlier statistics indicated.
At this point in the second summer of the Reagan administration, its two central economic ideas have failed the test. Both of them sought to avoid the pain and costs of the conventional counter-inflationary recession by invoking the magic of anticipation. If a president promises a huge tax cut, the supply-siders said, people will see it coming and will begin to save and invest in anticipation, creating a boom in production and productivity. The administration's monetarists claimed that a president's promise of monetary restraint would, by the sheer psychological force of anticipation, stabilize wages and end inflation without the customary layoffs and bankruptcies.
These ideas got a fair trial, and they have collapsed. There is no evidence whatever that there was any anticipatory effect, or that there will be any. On the contrary, the tax cuts have greatly added to the upward pressure on interest rates. The country is now in a recession from which present policy offers no plausible recovery. Others, if not Mr. Reagan, are now consequently beginning to change that policy.
Congress is moving courageously to pass a tax bill. The Federal Reserve is embarking on its own cautious adjustments. Mr. Reagan meanwhile began the week by leading the cheers at a rally for a constitutional amendment to balance the budget--an amendment that would take effect some years after his present term ends.