WASHINGTON — Can the U.S. economy avoid a recession in the wake of the stock market debacle? Some economists now are convinced that a serious economic downturn is inevitable within months. But many analysts insist there is no reason for the economy to fall significantly as long as government policy does not stumble badly in the days and weeks ahead.
"We can prevent this market crisis from turning (into a general economic collapse) by avoiding the three prime policy mistakes that brought on the Depression: protectionism, a tight monetary policy and sharp tax increases," said Robert Hormats, a former top Treasury official who is now with Goldman Sachs in New York.
So far, monetary policy-makers have passed their first test. Economists give high praise to the Federal Reserve for quickly reversing course immediately after the crash two weeks ago and flooding the banking system with money to prevent any danger of a credit crunch. Interest rates have already declined significantly.
The jury is still out on trade policy. Congress, according to the virtually unanimous view of economists, should reject the protectionist features of pending trade bills, lest today's trade tensions degenerate into a worldwide trade war.
Budget policy provides the trickiest choices. Although economists generally want Congress to avoid major tax increases that might depress the economy, they also recognize that long-term deficit reduction--including a politically palatable combination of modest tax increases and spending cuts--is an essential ingredient in easing the strains in the world economy that contributed to the stock market's crash in the first place.
Some economists believe that the government, no matter how wise its policies, lacks the tools to stop a recession.
"A recession is rising very quickly over the horizon," warned Irwin Kellner of Manufacturers Hanover Bank in New York, one of the most successful forecasters on the economy.
The reason, Kellner said: Consumers will spend less, out of fear that the market crash portends hard times ahead. Thus the fear itself, he warns, will generate the reality.
Could Aggravate Impact
Other economists hold that a recession is inevitable only if government decisions aggravate the impact of the stock market collapse.
David Levine, chief economist for the Wall Street firm of Sanford C. Bernstein & Co., said history is likely to look back on the market panic as "little more than a powerful but brief snowstorm. You'll notice a sudden, dramatic dip, but then the economy will return to its upward course as if almost nothing had happened."
In a curious way the debacle on Wall Street, instead of signaling an imminent economic decline, may trigger some actions that many economists regard as long overdue.
"The stock market crash may even help the economy," said Lester Thurow, a liberal economist at the Massachusetts Institute of Technology. "It will do so because it scared the Federal Reserve Board into changing its policies. Lower interest rates may well in the end stimulate the economy more than the stock market crash depressed it."
The crash also scared Congress and the Administration into making a serious effort to break their yearlong deadlock on budget policy. Administration officials and congressional leaders began meeting last week with that end in mind.
Finally, the crash may have dampened enthusiasm in Congress for protectionist legislation.
But in many economists' view, there remain two serious risks.
--The budget negotiations may succeed too well and yield a combination of spending cuts and tax increases that would depress the economy.
--The Fed, having initially opened the monetary floodgates, may close them prematurely to force interest rates back up if the international value of the dollar sags too far. U.S. interest rates and the dollar's value are closely linked because the bulk of foreign investments in the United States are in interest-bearing bank deposits and bonds.
The Fed can prop up the dollar by forcing interest rates up, thus making investments here more attractive to foreigners--but that can also dampen growth of the U.S. economy. This was the course the Fed followed starting last April--and ending with the stock market's collapse.
"I can imagine monetary policy being immobilized by the presumed need to defend the dollar, " said Herbert Stein, former chief economic adviser to President Gerald R. Ford. "I can imagine fiscal policy being immobilized by the presumed need to reduce the deficit in a declining economy. Both of those reponses would be rationalized as necessary to generate confidence, which would repeat the policy errors of 1931 and 1932."