That Monster Deficit

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In budget briefings with reporters, Feldstein suggested that the Administration would eventually have to compromise with Congress and agree to reduce defense spending and raise taxes. Grumbled a top White House aide: "There was Feldstein, in public, emphasizing that the budget as presented was a bad job and that, of course, defense will have to be cut and, of course, the Treasury needs more revenue. The Democrats will feel emboldened to stick to their guns all the more stubbornly." That same week the Administration released the Economic Report of the President, which was prepared under Feldstein's supervision and contained a stern new warning about deficits. An angry Regan advised members of the Senate Budget Committee that they could "throw away" Feldstein's report.

The squabbling among his advisers reinforced the President's deep distrust of economists. In a January radio address, he described economic forecasting as "far from a perfect science" and called economists "naysayers" and "doom criers." Though Rea gan was never a doctrinaire supply-sider who believed that deficits were nothing to get too concerned about, the President apparently refuses to believe that the budget gap will be as big and as harmful as Feldstein thinks.

To a large extent, Reagan has become his own economist. At a meeting last fall, Feldstein, Regan and Stockman presented forecasts showing that the deficit would rise to well over $200 billion in the last half of the decade. The President studied the figures and noticed that inflation, as measured by a broad index known as the G.N.P. deflator, which includes prices paid by both businesses and consumers, was expected to hover around 5%. "Why can't we continue to make progress?" the President demanded. "We can't just declare victory at 5%."

Having no ready answer, the economic troika went back to the calculators and produced a downward-sloping curve that showed inflation falling from 5% this year to 3.6% in 1989. Since interest rates are related to the level of inflation, the advisers trimmed their estimate of the 1989 rate on three-month Treasury bills from the 7%-8% range to 5%. By that statistical legerdemain, the projected 1989 budget deficit shrank from more than $200 billion to $123 billion.

The President's seat-of-the-pants forecasting and his refusal to listen to his chief economic adviser have raised serious questions: Is there any basis for Reagan's optimism? Is Feldstein right about the perils of deficits? Does a growing budget gap produce high interest rates?

Followers of supply-side theory have compiled a growing list of studies purporting to show that deficits do not raise interest rates. One was done by Manuel Johnson, an Assistant Treasury Secretary. Two other outspoken advocates of the supply-side view are Alan Reynolds, an economic consultant with Polyconomics in Morristown, N.J., and Paul Craig Roberts, a former Assistant Treasury Secretary in the Reagan Administration who is now a professor at Georgetown University. Supply-siders contend that the main factor propping up interest rates is the Federal Reserve's tight money policy. They argue that it was the Reserve Board that caused the recession and that if the 'Fed would loosen up, interest rates would come down and growth would stay strong.