Reagan and red ink: relaxing an anti-inflation tenet

It all began with an innocent answer. Treasury Secretary Donald Regan, facing a phalanx of senators during his confirmation hearing in January, offhandedly said he didn't think the federal budget could be balanced until 1984 -- significantly later than President Reagan had promised during the campaign.

Mr. Regan later admitted he did not know reporters would pounce on the remark as if it was a ladies' dropped handkerchief, to be waved on the nation's front pages as a sign of the new administration's backpedaling. At subsequent public hearings he said that maybe the budget could be balanced by 1983, after all. Other administration officials also said they thought the earlier date was within the bounds of possibility.

But now the President has ended the hemming and hawing with an official prediction. During his economic speech to the nation Wednesday, President Reagan rolled out a budget plan that calls for a balanced sheet by 1984. The deficit for the current fiscal year is projected to be $59 billion. Surprisingly, the deficit for 1982 is estimated at $45 billion -- $18 billion larger than the Carter administration's projection.

Is the nation's economy to be swallowed up in a sea of red ink? Are budget deficits inherently evil, things to be avoided at all costs?

"People believe that budget deficits are inflationary," says Tim Howard, an economist for the Wells Fargo Bank. "But their effect is more psychological than real."

Budget deficits fuel inflationary expectations, he says -- causing people to spend more, demand raises, and increase prices. But government deficit spending is not mechanically linked to inflation, he claimes.It's all in our minds.

Writing in Newsweek, Milton Friedman claims that "the relation between deficits and inflation is far looser than is widely believed."

Statistics seem to back him up. The federal deficit is about 3 percent of national income. In Japan, it's 6 percent -- yet the Japanese inflation rate is significantly lower than that of the US.

Inflation ran wild in America in 1974, hitting 12.2 percent.In 1979, it ran even wilder, reaching 13.3 percent. Yet in both years the deficit was relatively small, only 1 percent of national income.

Economists say the real problem isn't the deficit. It's how the deficit is paid for.

One way for the government to finance a deficit is for the Treasury to go into the private sector and borrow the money. This isn't inflationary, economists say -- but it can crowd productive private investment out of the market.

It sends interest rates up, increasing the screams from rate-sensitive businesses, like housing, urging an increase in the money supply.

"That puts all the pressure on the Federal Reserve and Paul Volcker [chairman of the Fed]," says Dr. Lawrence Ritter, author of the book "Money" and a professor at the New York University Business School.

The other way for the government to finance its deficit is to "print money" -- an analogy some economists say is misleading and others say is downright wrong.

There are no Washington printing presses roaring like runaway semitrailers, spewing out greenbacks to pay the government's bills. The Down East comedy duo of "Bert and I" can claim to stem inflation by making the US treasurer sign his middle name to each bill (thus slowing down the flood of money), but in real life it doesn't work that way.

"During the Civil War the government just printed money," says Dr. Robert Holland, president of the Committee for Economic Development and a former member of the board of governors of the Federal Reserve. "But we've evolved a system so sophisticated there are other ways to do it."

In effect, "Printing money" means "creating bank deposits." The federal Reserve, by buying government securities, creates bank deposits, which increases the money supply and the capacity of banks to make loans.

And, economists say, an increased money supply doesm foster inflation.

But some believe the term "printing money" is an inaccurate way of describing the process.

"It's a popular misconception," says Mr. Howard. "The only ways to pay for government deficits are by borrowing, or by tax receipts."

At the bottom line, most economists agree that government deficits are neither inherently inflationary nor inherently evil.

"A balanced budget is a goal we should strive to attain," Howard says. "But restoring incentives to produce is more important than trying to hit a zero on the budget deficit."

The government's balance sheet is a powerful symbol, however, which influences the way people view their economic future. The Reagan administration seems committed to cutting taxes, no matter the cost in red ink, as a way of curing economic ills.

"What happens in the next three or four months will shift people to one side or the other" in the fight for the Reagan program, Dr. Ritter says."In any case, I don't think Reagan can possibly [balance t he budget] in a year or two."