President Reagan's proposed 1987 budget released yesterday includes large cuts in federal spending that would restrain economic growth unless its impact is offset by an easier monetary policy and lower interest rates, according to a number of economists.
The new budget and projections for later years incorporate the deficit-reduction targets set by the new Gramm-Rudman-Hollings law, moving from an estimated deficit of $202.8 billion this year to $143.6 billion in fiscal 1987 and ultimately to a tiny surplus in 1991.
Council of Economic Advisers Chairman Beryl Sprinkel, who said there is no danger that the cuts would lead to a recession, called the cuts "modest," not "draconian."
But some other economists said the swing in the budget's impact on the economy is significant, being equal to more than 1 percent of the nation's total economic output.
The Federal Reserve Board "is going to have to take this into account," said Charles L. Schultze of the Brookings Institution, who was CEA chairman in the Carter administration. "They are going to have to increase bank reserves and engineer a decline in interest rates to achieve the sort of real growth they want."
The administration forecast sees increases in the gross national product, adjusted for inflation, of 4 percent annually for the coming three years. Real GNP rose 2.5 percent between the fourth quarter of 1984 and the final quarter of 1985.
Sprinkel told reporters that the economy could expand at a 4 percent pace this year even if the rate of growth of the money supply were reduced, as he said it should be to keep inflation from worsening. The budget document agreed: "The forecast for 1986 and 1987 assumes that monetary growth will decline gradually following its acceleration last year, while providing sufficient liquidity to sustain a healthy expansion. It also takes account of the effects of the large spending cuts proposed . . . "
To Schultze and other economists, such language amounts to a request that the Fed do whatever is necessary to keep the expansion going, and doing that will require lower interest rates.
An analysis of the new budget by the House Budget Committee staff released yesterday questioned whether the Fed, in fact, would be able to act promptly enough to offset restraint in the proposed budget.
The committee analysis estimated the swing toward restraint as being equal to 1.4 percent of GNP, or about $50 billion, between fiscal 1986 and 1987. This calculation was made using a so-called high-employment budget analysis, which seeks to abstract from changes in the actual budget deficit that are due to declines in unemployment. A reduction in the deficit that occurs for that reason would not mean that the budget was becoming more restrictive, according to this analysis.
"There is a serious question whether monetary policy can be adjusted in a timely way to sustain economic growth in the face of sharp fiscal restraint" such as that called for in the budget and the Gramm-Rudman-Hollings targets, the committee document said.
A decline in the size of the federal budget deficit would directly relieve some pressure on interest rates by cutting federal borrowing needs. And according to many analysts -- and the new budget document itself -- the prospect of lower deficits already has been a major factor in the recent drop in long-term interest rates.
"One part of the explanation for the fall in long-term interest rates is that there was a growing belief that the G-R-H amendment would pass and that it would mean a significant improvement in the federal budget deficit and, therefore, in the prospects for price-level stability over the longer term," the budget said.
In sharp contrast with some budgets from earlier years of the Reagan administration, the 1987 budget points to some economic dangers associated with continuing high deficits. The current language also contrasts with declarations by the president during his 1984 reelection campaign that economic growth would reduce the deficits and that they had no effect whatsoever on the level of interest rates.
"Over time . . . the effects of excessive federal borrowing are progressively debilitating," the budget said. "In the competition for borrowed funds, the federal government always wins. Private savings absorbed by the government are not available for lending to the private sector. In 1985, the federal deficit was more than 60 percent as large as total net domestic saving. Continued federal borrowing at this level threatens private capital formation and with it the economy's potential for future economic growth."
Those are precisely some of the warnings that critics of the administration budget policies have used in urging that action be taken to reduce the red ink, including some tax increases, if necessary.
Thus, economists such as Schultze say deficits must be reduced even if that risks temporarily slower economic growth.