The Outlook: The Economic Impact Of Gramm-Rudman
WASHINGTON -- The Gramm-Rudman plan to balance the budget will test the resolve of politicians and the wits of economic policy-makers, particularly at the Federal Reserve Board. To meet the law's rigid schedule, Congress and the president will have to impose politically painful spending cuts and, many believe, tax increases. Gramm-Rudman also presents economic challenges. There are risks that sharp cuts in the deficit -- and the fiscal stimulus it provides -- could depress the economy. Many analysts believe the transition to a balanced budget will be a manageable, important step toward a stronger, more resilient economy, but it will be difficult.</br></br>The stakes are high. "In terms of potential economic ramifications, this bill has no rival save perhaps the infamous Smoot-Hawley tariff of 1929," Boston College economists Barry Bluestone and John Havens recently told the Joint Economic Committee of Congress. "Gramm-Rudman mandates drastic cuts in the federal budget with the explicit purpose of reducing a string of $200 billion deficits to zero by 1991. How this Herculean task will be accomplished over the course of the next five years will ultimately affect every single measure of the economy. The rate of economic growth, the size of the trade deficit, the level of employment, and the distribution of income will all be profoundly affected depending on how this legislation is actually implemented."</br></br>The worst -- and least likely -- policy combination would be sharp spending cuts without any compensating ease in monetary policy. According to an analysis by Wharton Econometric Forecasting Associates Inc. last fall, "cutting the deficit to zero in 1991 using only spending cuts and assuming no offsetting stimulus, brings the economy to a grinding halt, pushing the unemployment rate to 17% in a few years," says Nariman Behravesh, a Wharton vice president.</br></br>"Of course," he stresses, "it's much more realistic to assume that such a huge cut in the deficit would be accompanied by significant monetary easing and a sharper decline in the dollar." Thus, declining interest rates would spur investment and a lower dollar would boost U.S. exports, helping to offset the slowdown in spending.</br></br>Mr. Behravesh warns that timing differences between the drag of spending cuts and the benefits from an easier Fed policy bringing lower interest rates could cause a temporary slowdown in growth and higher unemployment. But he argues that "it's well within the realm of possibility to get through this period of adjustment without much pain and suffering and in the long run we'd be better off" with an economy driven less by government spending and more by private investment and exports.