David Stockman's book has reopened debate on whether the Reagan Administration's economic actions have been based on a consistent philosophy of economic policy.
This debate in turn has raised the related question of whether sound economic policy is possible without accurate quantitative projections of the effects of alternative courses of action.
We believe that by any reasonable standard of practical politics, the economic policies of the first Reagan term were in fact guided by a clear and consistent set of economic principles. These foundations were occasionally obscured by the rhetorical excesses of the supply-side extremists and by inevitable compromises with political reality. Crucial budget decisions were based on faulty forecasts and excessively optimistic assumptions. But the economic philosophy of the first Reagan term was more clearly defined and consistently pursued than in any previous Administration since the end of World War II.
The key elements of this strategy were a tough monetary policy designed to reduce inflation and a tax and regulatory reform aimed at raising productivity and long-term economic growth. In addition, priorities shifted to trimming federal spending on non-defense programs while increasing funding for defense. All of this was to be done while bringing the budget into balance.
The President has pursued this strategy with remarkable tenacity. And, with the exception of the deficit, he has achieved much succcess. For example, the President remained steadfast in his view that eliminating excessive monetary expansion was the key to stemming inflation. His 1982 campaign theme of "staying the course" of disinflation in the face of the exisiting double-digit unemployment rate took courage and a strong conviction that his policy would soon bring lower inflation and improved economic growth.
But despite the Administration's impressive record in pursuing a consistent economic philosophy, the public lost faith early in the coherence of the Reagan economic program.
The credibility of that program was severely undermined when the 1981 rosy forecast of more than 5% real growth was disproven within months by the economy's slide into a most severe recession. Although economic forecasting is always difficult and administrations are notoriously unwilling to project an economic downturn, the 1981 prediction was far worse than usual--clearly inconsistent with the Administration's own monetary policy and contrary to the broad consensus of private forecasts.
When the economy shifted into recovery in 1983, the public's confidence in Reaganomics returned. But the rosy scenario of 1981 had done lasting damage by inadvertently hiding from the President and other Administration officials the severity of the fiscal deficits that would follow from the budget decisions they were about to make. The slower-than-projected economic growth and the unexpectedly sharp decline in inflation meant less tax revenue than had been forecast, a revenue shortfall that was exacerbated by Congress' decision to add more revenue-cutting features to the President's 1981 tax plan. The lower-than-projected tax revenues and the failure to get all of the spending cuts that the President had been hoping for gave rise to the massive deficits that have plagued our ecomomy for the past five years.
It's easy to criticize the 1981 forecast, but that's not the real lesson of the past five years. Economic forecasts are inherently uncertain and cannot provide an accurate guide to tax revenues over a four- or five-year period. The proper design of economic policy should reflect this inherent uncertainty by building in automatic flexibility.
The idea of such flexibility caused some of us back in 1981 to think that the final year of the personal rate cut should be made contingent on the future level of government spending and the resulting size of the deficit. This was not done, and by late 1982 it was clear that the country faced large and damaging budget deficits. Although there were those who urged a midcourse correction in the tax cuts to avoid these deficits, the President was persuaded to delay action by those advisers who created the fantasy that the country could grow its way out of the deficit without any tax increase.
The closest the Administration came to the idea of contingent fiscal policy was the proposal in the President's 1983 budget for a standby tax that would have been triggered if future deficit targets were not met. Unfortunately, opposition from Congress and especially from certain Administration insiders torpedoed this good idea.
The first Reagan term showed an appropriate steadfastness to principles but too little quantitative flexibility. What worries us now is that the President may be abandoning some of his original principles--sacrificing his support for anti-inflationary monetary policy in the pursuit of current interest rate reductions, and, in the pursuit of higher personal exemptions for middle-class taxpayers, reversing his 1981 support for tax policies that stimualted saving and investment. It would be doubly unfortunate if the President remained rigidly opposed to recalibrating tax revenue while abandoning the sound principles that guided his first term.