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Even if the Federal Reserve violates Volcker's commitment to tight monetary policy and pours out enough money to meet the borrowing demands of both Government and business, says Wenglowski, the eventual outcome could be, if anything, worse than the stagnation scenario. Interest rates would stay down temporarily, and production might grow rapidly and unemployment drop for a while. But then inflation would reignite, and sooner or later the Federal Reserve would have to crack down again to choke off the miniboom. That scenario would in effect mark a return to the dismal and overlapping inflation-recession cycles of the '70s.
On the deficit front, too, there are grounds for a little optimism. Passage of the threeyear, nearly $100 billion tax increase two weeks ago reassured Wall Street that the problem would at least be addressed. By lobbying all out for the bill, Reagan proved that he has moved away from the supply-side zealots, whose views of lower taxes as an economic cure-all had dominated the early months of the Administration. The President's tendency now is toward a far more traditional Republican philosophy that stresses holding down deficits. Congress showed commendable courage as well in raising taxes at the start of an election campaign.
The tax bill, though, is only the first, and probably the smallest, of the steps that have to be taken. Even after its passage, the nonpartisan Congressional Budget Office estimates that deficits will run around $150 billion in each of the next three fiscal years, dwarfing the record $110 billion now expected for the financial year that ends Sept. 30. The Administration, of course, calculates much lower figures, but it is assuming passage of spending cuts that Congress has not yet enacted.
Fundamentally, the problem is that the reductions in spending programs that Reagan has pushed through Congress so far have come nowhere near offsetting the income tax cuts that he got the legislators to enact in 1981. That is true even though most of the major reductions that can be hacked out of so-called nondefense discretionary programs, in which Congress decides every year how much to appropriate, have already been made.
Future spending slashes will have to come out of defense and the entitlement programs that guarantee benefits to people who meet certain standards, whatever those benefits may cost. Examples are Medicare, Medicaid and, above all, Social Security. Says Alice Rivlin, director of the Congressional Budget Office: "Any significant lowering of the deficit has got to include slowing of the defense increases, entitlement cuts including retirement programs [i.e., Social Security] and probably more taxes, all of those things. It is not a choice. You have to do them all."