Executive Summary: Walter Heller finds economic policymaking in greater disarray than anytime in the postwar era. He's right, but that doesn't mean 1983 won't produce better policy than 1982. Many of his top economic advisers see deficits impeding growth, but Ronald Reagan has to find a path to rapid, non-inflationary growth or the unemployment rate will undo him and the GOP in '84. Reagan himself may not take any initiatives, but he's receptive. Paul Volcker and Donald Regan need to push together to get a bandwagon of international monetary reform going. Jim Baker, for the time being, is a growth advocate. Martin Feldstein and David Stockman push "structural deficits" and low growth. George Shultz has elbowed his way into a leadership posture, but what will he do? Three institutes vie for leadership on inflationary, deflationary, sound money policies. Jack Kemp should have a better year and so should the economy.
Economic Leadership: 1983 Scoreboard
In The Wall Street Journal of December 28, Walter Heller declaims against "the disarray in U.S. economic policy," a 'Tower of Babel" as "the administration speaks with many, often contradictory voices." Professor Heller observes: "Time and again, Congress and the Federal Reserve — not the natural instruments for economic leadership — have been forced to take the initiative, with the President eventually signing on."
Heller's economic analysis is as stale as it is pompous, his prescriptions utterly useless to a President who may want to be re-elected next year. But he's a savvy political hand who's been around a long time, chairman of the Council of Economic Advisers under J FK and LBJ. And he's absolutely on target when he notes: "Economic historians would be hard put to find in postwar annals any greater policy disarray in the face of recession and financial crisis than besets Washington today."
As the New Year begins, it can safely be said that nobody knows exactly what kind of economic policies will emerge from this confusion. And it's not at all clear where economic leadership will come from. In an atmosphere as permissive as a Montessori kindergarten, the members of the President's team elbow, shove and spout off economic ideas that seem to change between breakfast and lunch. The President himself seems bemused by the babble around him, contributing his own off-the-wall ideas — a Christmas Eve appeal to employers everywhere to hire one more worker! Remember President Ford's WIN buttons? But with all the babbling and disarray, we're still likely to get better policy-making in 1983 than we had last year, especially if the President decides to get serious about an economic growth strategy.
At least we know Mr. Reagan is genuinely concerned about the unemployment rate, which is not a subject that seems to interest many of the folks around him. Not only do we hear no answers to the question: How do we find the path to rapid growth and high employment without inflation? We don't even hear the question raised inside the administration. With 1984 just around the corner, the President should be demanding counsel on how to get the unemployment rate down to 7 1/2 percent by October 1984, without inflaming the inflation rate. The achievement, after all, would guarantee a Republican landslide. But he may be afraid to ask, knowing he won't like what he's told.
The reason, of course, is that by this time, at his mid-term, Mr. Reagan is surrounded by demand-siders or advisers who themselves are advised by demand-siders. And to the theoretical manager of aggregate demand, who operates through the pockets of aggregate consumers, it isn't possible to reduce unemployment and inflation simultaneously — especially at the blistering pace of economic growth implied by a 7 1/2 percent unemployment rate by the end of 1984. You can't put money into consumer pockets in order to combat recession as you are also withdrawing money from consumer pockets in order to reduce the upward pressure on prices.
Even supply-side economists question whether three points could be knocked off the jobless rate in less than two years, given the generous level of unemployment and welfare benefits and the consequent disincentive effects involved. Columbia University's Robert Mundell insists that it could be done with a policy mix ambitious enough to overcome the disincentive effects of the entitlement programs. But at least supply-siders are unanimous in agreeing that rapid growth without a revival of inflation can be achieved in the next two years.
This may seem Pollyannish among Wall Street economists, but it has become the dominant view in the financial markets themselves. The Dow Jones Industrial Average is not making alltime highs lately because it anticipates a flat economy in 1983; the continuing bull market in stocks and bonds is an implicit forecast of rapid growth and diminished future inflation. Given no change in current policy assumptions, the average supply-side forecast of real GNP growth in 1983 is about 6 percent. This is roughly double the conventional consensus forecast, triple the puny administration forecast of 1 1/2 to 2 percent real growth, a miserable recovery that wouldn't even dent the 10.8 percent unemployment rate. Fortune magazine's January 10 issue forecasts a 1.8 percent GNP advance for 1983, but then a year ago it said the economy would be "chugging along at 3.3 percent" by the end of 1982. H.C. Wainwright & Co. of Boston was the only supply-side firm to issue an unconditional forecast for 1982; a year ago it reckoned minus 2 percent via an implicit market forecast and the actual number will be about minus 1.8 percent (Wainwright now sees 6.7 percent for 1983).
From a political perspective, the chief worry is that the austerity forces behind the administration's budget forecasts will be successful in forcing the President into playing their game again. As long as there is no economic leadership in evidence around the White House, no sign of an economic-growth quarterback with a comprehensive strategy, there remains the danger of ad hoc monetary and fiscal policy changes that could rapidly turn the financial markets into forecasters of future recession. The President's acceptance of a low-growth projection would increase chances of this becoming a self-fulfilling prophecy.
Where is the economic leadership coming from in 1983? Let's examine the possibilities.
Ronald Reagan: All of a sudden, everyone's favorite word for the President is "compromise." As if Reagan did not spend all of 1982 compromising, the news media is now singing the establishmentarian line that the President has to be more flexible this year, especially now that there are 26 more House Democrats. This means he must be more willing to cut defense spending and even more willing to raise taxes. This, in order to reduce the projected deficits that flow from his economic team's low-growth projections. In the spirit of "compromise," the Democrats seem willing to move up the July 1 tax cut by a few months, knowing RR will never allow it to be scrapped anyway. In exchange, they'll demand the scrapping of the indexing feature that is now scheduled to take effect in 1985.
The best we can expect from the President is to resist the pressures to compromise on tax policy, and he is likely to do a good job of that. This, in fact, is a fairly solid basis for optimism about 1983. Reagan may not be up to leading a charge for growth. But with two years as President under his belt, it's not likely he's going to be talked into tax increases again as a compromise move to balance the budget. If anything, he probably regrets the $100 billion tax increase he swallowed last year, a burden the economy could do without right now. He will take a pasting from the establishment press for his refusal to compromise in the face of $190 billion deficit projections. But his recent interviews indicate he possesses a reasonably high level of confidence in following his instincts on fiscal matters. We can't expect any initiatives from him in 1983, but we can be thankful if he only pays a solid defensive game.
Paul Volcker: Time magazine demonstrated it is out of touch by naming the computer as its "Man of the Year." It was Volcker going away for any such distinction. He had the whole world on a string throughout 1982, playing it like a yo-yo. First, bringing us to the edge of international banking collapse, then ushering in the dazzling bull market that offers such hope for '83 and beyond. In the seven months he has left as Fed chairman, we can count on him to prevent a new outbreak of monetarism. And, we believe he will, without saying so, try to keep the price of gold from swinging wildly as it had in the first three years of his chairmanship. But unless he's blinded by a flash of inspiration on the yellow brick road to Damascus, Paul will not be the economic-growth leader we're looking for. A child of the banking establishment, he moves by millimeters even when changing directions, sticking as close to the conventional consensus as he can get. The good news is that he will be among the first to jump on a bandwagon for international monetary reform once it gets rolling. Meanwhile, in the absence of public commitments to stabilize the price of gold, or to peg the price in cooperation with Treasury, Volcker appears to have no strategy to keep interest rates from rising in the recovery. The markets will be inclined to bet that Volcker will give in, by millimeters, to pressures for much lower interest rates that would soften the dollar and send the price of gold up. In other words, we're in same position Mexico gets itself into once a year. The private markets speculate we will devalue the dollar and by defensively moving out of dollars accomplishes the devaluation. In the absence of a public government commitment to defend a specific dollar value, a ceiling price of gold, the Fed can thus find itself in the midst of a reflation. We can't expect any such public commitments coming from Volcker.
Donald Regan: The Treasury Secretary has the capacity for leadership and the inclination; he's not a bureaucrat. But he doesn't know which way to go, spun in different directions on fiscal policy by the supply-side fiscalists and tax lawyers who've had his ear these two years, and brainwashed by that penultimate monetarist, Beryl Sprinkel, on domestic and international money matters. His heart is with the growth forces, but his weak staff keeps him ineffective. In the lame duck session, he expressed regret for his support of last summer's tax boost and plumped for acceleration of this July's tax cut. But then he lets David Stockman bamboozle him with deficit projections, signs off on the Stockman-Feldstein low-growth projections, and is next seen in The New York Times contemplating loophole-closing tax increases. In Frankfurt last month he surprised everyone with a call for a new Bretton Woods international monetary reform, a marvelous idea. But after a lot of excited chatter, the potential players are forced to conclude that it's all hot air. It's something Donald Regan would like to do if he had a staff. Rumors persist that Sprinkel is on the skids. But until we see it happen and also see Regan bring in a few heavyweights, we can expect to see him continue walking in circles.
James Baker III: The White House chief-of-staff is definitely on the growth team these days. The Baker-Stockman alliance ended when Baker sensed the administration had been pulled into the orbit of the 1984 elections. The White House simply can't accept the implications of Stockman's projections and austerity strategy now that it all but guarantees double-digit unemployment in November 1984. But this short time horizon might make Baker open to seduction by those who would abandon the indexing of 1985. He is still intimidated by the Stockman deficit projections and is probably going to lean as hard as he can to squeeze down military spending. Paul Thayer of LTV, recently installed by Baker as Undersecretary of Defense, is an advocate of reduced defense spending. Baker is also amenable to the idea of a growth-oriented monetary policy, especially now that he's seen the Fed's power to boom the financial markets in a policy shift. But his understanding of monetary policy is extremely thin and he still thinks in terms of "the money supply." Like Donald Regan, he has nobody within earshot who knows enough to keep him on a growth path. But it's important that he thinks that's where he wants to be.
Martin Feldstein: The chairman of the Council of Economic Advisers is dangerous because he really thinks he's smart enough to provide economic leadership. The establishment loves him because he's opposed to growth, because it's inflationary. The press corps loves him because he's willing to "tell it like it is" at the drop of a microphone. But beneath his bespectacled visage resides a medium-grade scatterbrain. Over the years Feldstein has been a true eclectic, piecing together various slabs and remnants of every known economic model, demand-side and supply-side. Much of the confusion that currently envelops the Reagan administration results from his penchant for throwing press conferences to exhibit his wisdom. But there is nothing in his bag of tricks that can tell the President how to achieve rapid growth without inflation, except perhaps by taxing the unemployed and eliminating the Social Security System. He's a natural ally to David Stockman, a drag on the President.
David Stockman: The director of the Office of Management and Budget is more of a threat than ever to the forces of growth, doubly dangerous because he's running out of time and allies. Stockman remains fanatical in his neo-Hooverian belief in the Deficit Theory, and in his own genius. There are those, like Paul Craig Roberts, who completely believe Stockman is powerful enough (and unscrupulous enough) to single-handedly thwart economic growth and thereby ensure the stupendous deficits he is predicting. But just as he has lost the rubber-stamp support of Jim Baker, because of 1984 presidential politics, he will also find a less receptive Senate for his austerity campaigns. The big Senate Republican class of 1978 is up in 1984 and it already calculates that double-digit unemployment will be bad for its health. Stockman's best hope is to get the White House to accept his low-growth, high-deficit projections, along with his "structural deficit" arguments, and at least force the spotlight of national debate onto his turf, away from monetary policy. He might get lucky and do a deal to get rid of indexation. At least he could keep attention focused on deficits instead of unemployment and recession.
George Shultz: The Secretary of State has elbowed his way into domestic arid international economic policymaking. Donald Regan doesn't seem to mind that his friend George is gobbling up his turf, which could only happen along with the discounting of Beryl Sprinkel. Now that monetarism has been given the heave-ho and "stable exchange rates'" are coming back into fashion, Shultz could become a positive force, providing the flip side of his role a decade ago in floating the dollar. His right hand man at State, Undersecretary Kenneth Dam, is exactly the kind of heavyweight Donald Regan could use to prepare a Bretton Woods agenda.
The Institute for International Economics: Rep. Henry Reuss has retired, which is no small reason for being optimistic about the 98th Congress and 1983. An arch-enemy of sound money and the leading inflationist in Congress for a generation, Reuss helped blow up the international monetary system in 1971; it will be much easier to restore a sound money standard with him gone from the Joint Economic Committee. Liberal Democrats, who as a rule tend to represent the interests of the debtor class which is served by monetary inflation, will now look to the Washington-based Institute for International Economics for strategic thinking. The ME is devoted to monetary inflation. C. Fred Bergsten, Richard Cooper and Peter Kenen are the academic heavies involved, all are allied with Yale's James Tobin, the Nobel Laureate who has made a career of an easy-money, high-tax policy mix. Bergsten has not made a speech in a dozen years that has failed to call for a devaluation of the dollar. Their views are given prominence in the New York Times and Washington Post and they represent a serious obstacle to monetary reform.
The American Enterprise Institute: As Democrats tend to represent debtors, Republicans tend to represent the creditor class, which is served by monetary deflation (which they call "disinflation"). The AEI economists stand as counterweights to the ME group and are equally opposed to sound money. AETs Gottfried Haberler a dozen years ago urged "benign neglect" of the dollar; Herbert Stein is among the most ardent champions of monetary deflation.
The Lehrman Institute: In order to have inflation or deflation, the dollar must be permitted to float, allowing liberals and conservatives to take turns in power on behalf of their constituencies in this zero-sum game. The Lehrman Institute in Manhattan is the focal point for global monetary reform that seeks to end the political struggle between debtors and creditors over monetary manipulation. This is the ultimate benefit of a gold standard, but also the reason why it is so passionately opposed by the deflationists/inflationists. Lewis Lehrman, who narrowly lost his bid for the New York governorship, will be a prominent and active advocate for global monetary reform in 1983. His institute is likely to play a major role in preparing the way for a new Bretton Woods.
Jack Kemp: The leader of the pro-growth forces when Ronald Reagan is absent, as he was throughout 1982, Kemp was thrown for losses all year by the austerity opposition, which was determined to have its recession. But he is easily identified as the only player in town who has a strategy for rapid economic growth without inflation. He'll have his hands full in 1983, but it should be a much better year. The President is back in a supply-side mood on fiscal policy and the Fed is not going to deflate. As the year opens, Kemp's task is to discredit Stockman's deficit projections and theory of structural deficits in order to prevent them from dominating Republican policy in the White House and Congress. The livelier the economic advance in the early part of the year, the easier it will be to gather political strength and hold off the Old Guard. Stockman and his allies in Congress counter with a "spending freeze" plan that Kemp opposes as an abdication of political responsibilities in setting priorities. On monetary policy, it's entirely up to Kemp to move things along toward basic reform, to at least get a bandwagon in motion. It wouldn't take all that much. A few words from the President giving his Treasury Secretary a pat on the back for his initiative, for example, would probably do the trick. If Kemp lands a seat on the Joint Economic Committee, chaired this term by a hard-money sympathizer GOP Senator Roger Jepsen of Iowa, there will be ample opportunities to develop a congressional constituency for reform.
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The Tower of Babel in Washington at the turn of the New Year is, then, not necessarily grounds for pessimism. Every now and then the babbling has to stop in order for a decision to be made, and we are now able to reckon that there's a much higher chance of good decisions being made than there was a year ago. Monetarism is no longer in the saddle and it's a safe bet it won't be back this year. Once again the President's growth instincts seem to have the support of his chief of staff, who a year ago was on the Stockman team. The economy seems poised for a nice recovery, and with a few breaks it could turn into a memorable one. We haven't admitted such enthusiasm for the prospects ahead since the 1980 elections, and look forward with keen anticipation to the unfolding of '83