Recovery plan: Can America's dollars do the quickstep?
Imagine all the dollar bills and checkable bank accounts in America seated in a large auditorium. "Look," says President Reagan, addressing them from the stage, "I know my economic recovery program is going to be tough on you guys. My friend Paul Volcker, over at the Federal Reserve, is going to limit the increase in your numbers. But I'm predicting the economy will expand, which means that you, the nation's money supply, will have to pay for a lot more business activity. Each and every one of you will just have to go out there and work harder by moving around faster. It'll be a challenge, but I'm sure you can do it."
If the money supply could listen, that's what the President would tell it. But critics are saying the increase in money's workload would be too much. They claim America's economic recovery may wither while it waits for financing --perhaps undermining the administration's political will to fight the nation's worst economic problem, inflation.
The debate centers on monetary "velocity," a term brought into general use early in this century through economist Irving Fisher's classic quantity theory of money. In effect, "velocity" measures how fast money changes hands.
The White House predicts that nominal GNP will grow about 11.5 percent a year over the next four years. At the same time, it has patted Paul Volcker on the back for saying he intends to gradually tighten the reins on the money supply, cutting growth in half by 1986 from this year's ceiling of 6.0 percent.
Since the economy will grow faster than the money supply, both goals can be met only if the available money circulates more quickly. To reconcile the figures, administration officials have said, velocity must grow between 6 and 7 percent a year -- what critics call historically unprecedented rates.
Brookings Institute economist Barry Bosworth says velocity of M1B (the most widely watched money measure) has increase an average of 4 percent a year over the last decade. "If there's one place supply-side economics is going to work," he quotes a colleague as saying, "it's going to be on the money supply. Money is reallm going to work hard."
A Brookings report on the budget released last week calls the velocity predictions "outside the range of historical experience." It adds that rising interest rates would be required to discourage demand for funds and keep monetary growth on target. GNP would then suffer.
"Such a policy of monetary restraint would fall heavily on investment, negate much of the effort to stimulate capital formation, and result in sluggish growth ," the report says.
Robert Genetski, a vice-president at Harris Trust & Savings Bank in Chicago, agrees that velocity goes up about 4 percent annually, a figure he says would support nominal GNP growth of about 7 percent, but "certainly not 12 percent."
Velocity fluctuates up and down according to the state of the economy.In a recession, people and institutions tend to hold on to their money, slowing its flow. When an economic recovery begins, everyone rushes out to satisfy his pent-up buying needs, causing velocity to increase.
Thus a surge of spending brought on by Reagan's program could blip velocity up from 4 percent.
But the peak probably wouldn't be enough, says Tim Howard, an economist for Wells Fargo Bank. And velocity wouldn't stay high enough "for the length of time they're projecting" to power the predicted growth in GNP.
On the other hand, a congressional subcommittee report says the needed speedup in velocity will occur.
"In my own view, there is empirical evidence to back it up," says Timothy Roth, an economist for the Joint Economic Committee and author of the report.
Mr. Roth cites the 1964 income tax cut, which spurred velocity from 2.95 to 3 .79 percent, as historical precedent.
Roth says the President's program will free some sectors of the money supply which otherwise wouldn't have been available for productive investment by encouraging cash balances to flow into stocks and bonds. He claims it will also "smoke out" money from the off-the-books "underground" economy, a pool of dollars estimated at anywhere from $100 billion to $200 billion.
An administration official responds that the whole debate reminds him of the medieval wrangles about how many angels could dance on the head of a pin. It's a trivial detail, he feels, because economic figures are so rough and changable.
The money supply-GNP linkage is "one of the most reliable relationships in economics," Genetski says.
Other economists paint this scenario: If monetary restraint and fiscal expansion pull in opposite directions, monetary restraint will win.
The result, according to economist Herbert Stein, now at the University of Virginia, would likely be a declining inflation rate, with less than predicted production and higher than expected unemployment. The budget probably could not be balanced by 1984.
"This is not the worst of possible outcomes," Mr. Stein writes in the American Enterprise Institute's Economist. "In fact, it may be close to the best available." The real problem, he writes, is that this situation might not please the American people, whose politicians have often promised them that inflation can be ended painlessly.