That Monster Deficit

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The supply-side movement, however, has had very little impact on the thinking of mainstream economists ranging from liberals like Barry Bosworth of the Brookings Institution to conservatives like Alan Greenspan, who served as President Ford's chief economic adviser. Traditional economists admit that many factors influence interest rates and that the stance of the Federal Reserve is perhaps the most important. But most would argue that if all other factors are held constant, the higher deficits go, the higher interest rates will ultimately be. The proposition is as simple as the law of supply and demand: if the Government sharply increases its demands for credit because it is running larger deficits, then the price of credit tends to rise.

To most economists, the question is not whether a credit squeeze will occur, but how soon it will hit and how severe it will be. Says John Wilson, chief economist of San Francisco's Bank of America: "The danger is that if interest rates go up from their current high levels, it won't take much to squeeze out private spending and drive the U.S. back into a recession in 1985." A survey released last week by the National Association of Business Economists found that 69% of the 237 members polled were worried that the deficits could bring on a downturn next year.

Whether or not that happens depends in large part on what the Federal Reserve Board does. The deficits force the seven governors on the board to choose between two extremely unpleasant choices: 1) they can hold down money growth, let interest rates rise and risk a recession; 2) they can expand the money supply enough to accommodate the deficits and possibly rekindle inflationary pressures. Chairman Volcker and several other board members have signaled their determination not to give up the progress that has been made against rising prices. Says one governor: "The Fed is going to stick it out." But another governor thinks that the board would have to back down in a crunch. Says he: "If a crisis develops that would cause a serious downturn in the economy, we should do what is necessary to remedy this. But you have to realize that the cost of such action can be renewed inflation." A jump in food costs brought on by bad weather caused the consumer price index to jump .6% in January, its steepest gain in nine months, but most economists remain hopeful that inflation will stay moderate this year.

Even if interest rates do not rise enough to spark a recession, they could discourage the capital spending that companies need to modernize and expand their capacity. Investment has begun to revive during the recovery, but much of the money has gone for computers and automation devices, rather than for the heavy machinery and new factories needed for long-term growth. Spending for construction of industrial plants fell 24% last year, and is expected to be flat in 1984. Businessmen seem to be reluctant to make investments that will not return a sure profit within a short time. Explains Robert Ortner, chief economist of the U.S. Commerce Department: "There is a fear that deficits will strangle the economy, which creates uncertainty. And uncertainty is always detrimental to long-term business decisions."

The Gang of Three against deficits—Feldstein, Volcker and Stockman—argue that the red ink damages the