Behind the economy's problems: federal spending, plus a lot more

What knocked the US economy off its feet?

President Reagan contends that the culprit is a corpulent federal government, bloated by excess spending that began in the early 1960s.

''The President's line of reasoning is right, but it certainly doesn't tell the whole story,'' says Michael Boskin, a Stanford University economist.

Many economists trace the economy's problems back to the era of Lyndon Johnson. But they say that economic shocks beyond the government's control - the sharp increases in oil prices and food prices in the 1970s, for example - have also battered the economy. And, they add, the fight against inflation has proven a costly battle.

In his Oct. 13 televised speech on the economy, Mr. Reagan repeated what he's been saying since he took office: Over the last 20 years, out-of-control government spending has led to high taxes and whopping deficits, which in turn have bullied the Federal Reserve Board (the Fed) into allowing inflationary increases in the money supply.

''Inflation, and the high interest rates it leads to . . . create the economic climate which leads to unemployment,'' in Reagan's words.

''At the bottom of it all is inflation - government-caused inflation,'' he said.

The first link in the President's chain is the assumption that government is too big, and is growing too fast. This is a central theme of Reagan's presidency , and influences how almost everyone in Washington talks about economics. Even unabashed liberals in Congress say: Yes, we need to control government spending, but. . . .

In 1961 the US government spent $94.3 billion. By 1981, in dollars unadjusted for inflation, government outlays were $599 billion, a sixfold increase.

This growth is less breathtaking, though still significant, when measured against the corresponding growth of the economy. In 1961, government spending was 19.2 percent of the US gross national product. In 1981, it was 23 percent of GNP.

New Deal and Great Society programs, such as social security, medicaid, and various welfare programs that pay benefits to individuals, have been ''the overwhelming force behind the growth of the (federal) budget,'' says John Ellwood, a Dartmouth professor of public policy and author of a recent Congressional Budget Office study on balancing the budget.

These so-called transfer programs accounted for a bit more than a quarter of government spending in 1965. By 1981, they were just short of half the federal budget. The growth of grants to state and local governments and the interest paid on the national debt has also been significant.

Has the government, swollen by growth of transfer programs, become so large its very size has caused inflation?

Not exactly, say economists.

''Basically, we've had inflation because we've had too much monetary expansion,'' says Herbert Stein, chairman of the Council of Economic Advisers under President Nixon. ''Government spending probably contributed some to this expansion.''

During the 1960s, President Johnson tried to pay for both the Vietnam war and the expanding cost of transfer programs without raising taxes. In 1960, the federal budget showed a surplus. By 1967, the deficit was $8.7 billion.

This shortfall, though picayune by today's standards, was partly covered by the Fed creating more money, an act which adds to the inflation rate. Since then , an ever-expanding government budget has forced the deficit higher and higher. And the Fed has alternately tightened and loosened the money supply.

The bigger the deficit, the more chance that the Federal Reserve ''will take an inflationary course in accommodating that deficit,'' explains Dr. Robert Holland, president of the Committee for Economic Development.

But government deficits aren't the only source of pressure on the Fed.

''There are a lot of other things that can cause inflation,'' says Rudolph Penner, an economist for the American Enterprise Institute.

OPEC, for instance. In 1972, after two years of gradual decline, the inflation rate was 3.4 percent. Then OPEC struck: In 1973, energy prices rose 17 percent. The next year, they rose another 22 percent.

Although oil shocks weren't the only cause, inflation was 12.2 percent by 1974. The inflation rate didn't hit double digits again until 1979 - a year when oil prices went up 37 percent.

''OPEC was part of the problem,'' says Herbert Stein.

Sudden jumps in other commodity prices, such as the robust upward bounds taken by food prices in the mid '70s, also add to inflation.

Many economists say inflation is not entirely ''government-caused,'' as Reagan implies. And it isn't inflation itself that has caused the current double-digit unemployment rate, they say. The fight against inflation has sent the number of jobless soaring.

Throughout the '70s, the economy was battered by a number of continuing problems. Productivity growth had been slowing for 15 years. Smokestack industries such as autos and steel did not age gracefully. The US became more dependent on exports, while the world economy remained mired in recession.

Against this background, Fed chairman Paul Volcker in 1979 tightened up on the money supply to fight inflation. Eventually, this move knocked the economy flat on its back. Unemployment climbed to a post-World War II high of 10.1 percent by September of this year.

''As inflationary psychology became more and more ingrained, the cost of getting rid of inflation has risen. That's why we're paying the high cost we are now,'' says Mr. Penner.

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