It is rare to see an administration more pessimistic about its own economic policies than private economists and the financial markets. It is rarer still to see an administration going to ridiculous lengths to scuttle those policies. But such is the economic forecast of President Reagan's Office of Management and Budget and his Council of Economic Advisers.
Given last summer's abandonment of monetarism, and with American taxpayers about to receive their first net tax reduction, it is hard to see why this economic recovery should be much below normal. Since World War II, the average growth in the first four quarters of a recovery has been 6.7 percent. Twenty- one private forecasters predict an average growth of 4.8 percent in 1983, and private estimates are being revised upward to take account of the rising stock market, last year's halving of interest rates and other favorable market indicators.
Nevertheless, OMB-CEA's prediction of 3 percent real growth in 1983--1.4 percent on a year-over-year basis--would make this the worst economic recovery in history. The difference might be explainable if private forecasters were habitual Pollyannas, or if OMB- CEA had a better predictive track record. But OMB- CEA predicted 3 percent real growth in 1982, when real GNP actually fell by almost 2 percent. Ironically, the OMB deficit projection for FY 82 was almost correct--because estimating errors offset the 5 percentage-point miss on real GNP! H.C. Wainwright & Co. of Boston--to take an example--accurately predicted last year's 2 percent GNP drop. The firm predicts 6.6 percent real growth in 1983 and 7.5 percent in 1984.
Such growth rates are little to write home about when the economy begins from levels far below capacity. From 1934 to 1936, for example, real GNP growth averaged 11.8 percent a year. If housing starts recover to only 1.5 million this year--historically a poor showing--it will still be a 50 percent increase. If auto sales recover only to their depressed 1981 levels, they will still rise 25 percent.
Perhaps the strangest thing about the administration forecast is the assumption that the Federal Reserve will drastically reverse its monetary policy. National income last year grew more slowly than the money supply, which is not uncommon during a recession; in economic jargon, the "velocity" of money fell significantly. Every time this has happened in the past, velocity has risen the following year at a rate of 5 to 7 percent. Even if the Fed had stuck to its old 5 percent money growth target, national income could be expected to grow in the neighborhood of 10 to 12 percent this year. With 5 percent inflation, this implies real growth of at least 5 percent.
Especially in view of last year's 8 percent rise in the money supply, the 1.4 percent growth forecast would make sense only if the Federal Reserve defied explicit congressional instructions to maintain current policy and slammed on the brakes in the face of declining inflation and a worldwide debt crisis. But if this happened, the OMB-CEA forecast would be far too rosy.
Aside from the forecasts themselves, there is the troublesome OMB-CEA "black box" that processes them. According to the "black box," although the deficit increases primarily because of economic weakness, it is not reduced commensurately with economic recovery. Just where this much-vaunted "structural deficit" comes from is still a mystery.
The policy implications of the forecast are enormous, since the budget estimates are largely driven by the underlying economic assumptions. For example, each percentage point of unemployment increases the deficit $39 billion, while each point of real GNP growth is worth $28 billion. A slow recovery in the first two years locks in big deficits, because unemployment stays about where it is, revenues are flat, spending rises and borrowing costs feed on themselves.
The Congressional Budget Office estimates that with an average recovery in 1983 and 1984, the "base-line" deficit after 1983 would be in the $120 billion-to-$140 billion range. This is before Congress even lifts a finger to keep Social Security self-financing, which will remove another $20 billion to $35 billion. In short, with a normal recovery in 1983 and 1984, the deficit is manageable with judicious but not Draconian spending restraint.
But if Congress accepted the OMB-CEA forecast, big deficit forecasts would become a self-fulfilling prophecy. Presumably, Reagan's budget will not propose major tax increases or defense cuts below safe levels. This means that a $200 billion-to-$275 billion OMB-CEA deficit would have to be addressed by cuts in the rest of the budget.
But under the OMB-CEA forecast, unemployment stays above 9 percent through 1984 because of economic weakness. Under such conditions, Congress would refuse to make serious cuts in social spending merely to change numbers on a page from, say, $275 billion to $240 billion. More likely, Congress would ignore the president's budget, seek to gut defense below the Carter levels and pass a tax hike that would make last year's monster look tame.
Since a tax increase weakens the economy further, though, the budget would have to be re-estimated, offsetting the hoped-for revenue gains. Last year's tax increase repealed 85 percent of Reagan's business tax cuts to raise $98 billion in FY 1983-85. But the latest OMB-CEA revenue forecast is $166 billion lower for 1983-1985 than Congress anticipated when it agreed to hike taxes--a net revenue loss of $68 billion.
The president needs a dynamic program, not one that will be dead in the water 24 hours after presentation to Congress. Such a program might include: thorough spending restraint; accelerated tax cuts; specific job-creating measures, like enterprise zones; removal of Social Security trust funds from the unified budget (and thus from partisan politics); support for the new Federal Reserve policy; support for Treasury Secretary Donald Regan's call for an international conference to reform the world monetary system and help settle the Third World debt problem; and a commitment to unhindered trade and aggressive access for our goods in other countries. We were elected to cure austerity, not to institutionalize it.
As Albert T. Sommers of the Conference Board argues, "without growth, there will be no budget solution." One way or another, the OMB-CEA forecast is unacceptable. If 1.4 percent growth is the best we can do, fiscal and monetary policies should be drastically changed to make a normal recovery possible. If the forecast is wrong--as I am persuaded--it should be changed.
But if the administration goes ahead with its bizarre forecast, our best hope is that Congress and the administration will wander aimlessly until reality overtakes the OMB-CEA forecast. Then Congress can take a more realistic look at the serious but tractable budget problem.