Trend of the economy

The Reagan administration's internal clash over the defense budget in a sense is a sideshow, obscuring a fundamental split among the President's economic advisers.

That split does not concern ultimate goals for the economy on which all the Reagan people are generally agreed.

The disagreement centers on which path to follow -- or to emphasize -- in reaching those goals, with adherents of both sides planted in key policymaking positions within the administration.

On one hand are the monetarists, who believe that the prime cause of inflation is bloated growth of the money supply over a period of years.

The cure for inflation, in this view, is to restrict the amount of money in circulation -- to keep the Federal Reserve Board from "printing money" to accommodate persistent budget deficits.

Thus the monetarists applaud the Fed's current restrictive course, though some criticize chairman Paul A. volcker and his Fed cohorts for not doing the job well enough.

Indeed, a tight money policy has begun to chip away at inflation, but at the cost of sky-high interest rates, which drag down economic growth.

On the other side stand "supply side" economists, fervent backers of the massive tax cuts -- $749 billion over five years -- pushed through Congress by Mr. Reagan.

These tax cuts, supply-siders argue, will act as a cornucopia from which many benefits will flow.

Businessmen and families, with more money left in their hands, will be impelled to save and invest, resulting in more jobs and brisker economic growth.

Many economists warn that the administration's policy paths toward these goals, exemplified by monetarists and supply-siders, do not appear to be parallel. At some point they may collide.


Assume that the economy, spurred by the tax cuts, does shake out of the doldrums and begin to grow. People go back to work. They demand more and better goods. Manufacturers compete to provide them, partly by building new plants and buying better equipment.

To do so, they must borrow. Merchants, meanwhile, stock their shelves higher to satisfy demand. They also borrow.

But where do they get the money, if the Fed -- urged on by monetarists in the administration -- is restricting credit?

"Stimulation of the economy through a major tax cut," said a top Federal Reserve Board source, "threatens to stimulate the demand for money."

Basically, there are two ways in which an increased demand for money could be met:

* The Fed could allow the money supply to expand, a course which everyone agrees would spur inflation. Volcker insists he will not let up on the credit reins and administration monetarists would be on his back if he did.

* If credit remains tight, the velocity of the money supply -- that is, the rate at which money changes hand -- would have to increase greatly to satisfy demand. Fed experts find no historical precedent for the velocity of money growing at such a pace.

This portends a squeeze, with fiscal, or tax, policy stimulating growth and monetary policy throttling it back. One result -- if people compete for scarce credit -- would be continued high interest rates.

This tendency would be worsened, if the White House fails to balance the budget and the US Treasury borrows heavily to finance government debt.

Administration officials, monetarists and supply-siders alike, paper over any contradiction and scoff at the notion that a policy collision lurks down the road.

Economic growth, they contend, will generate enough new tax revenue -- together with additional spending cuts -- to balance the budget in 1984, on schedule. This would withdraw the federal government from the credit markets, relieving pressure to that degree.

Beyond that, administration officials foresee a lowering of inflation, permitting the Fed to ease up enough to bring interest rates down.

The outlook, as the Reagan team portrays it, is not for collision, but for sustained growth (a result of fiscal policy) in a noninflationary economy (fostered by monetarists and the Fed).

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