Budget Deficit: Bane or Blessing? CONCERN SHRINKS

WHEN Richard F. Hokenson, an economist with the Wall Street firm of Donaldson, Lufkin & Jenrette, visited clients on the West Coast earlier this month, few asked about the budget deficit. ``Concern has gone down,'' says Mr. Hokenson.

Two or three years ago institutional investors would have bombarded Hokenson with questions on the huge deficit. Would it boost inflation and interest rates? Would it prompt a recession?

Contrary to expectations, nothing terrible happened to the economy. Inflation and interest rates went down, not up. The expansion has continued into its seventh year. Prices and interest rates have only recently risen modestly.

These days, indeed, several economists are playing down the deficit.

For example, Robert Eisner, a professor of economics at Northwestern University, says government actually has a surplus of $42 billion, not a deficit of $155 billion. He reaches this result by subtracting depreciation on government capital assets from the deficit, by taking account of budget surpluses run up by state and local governments, and by figuring the impact of inflation on the $2 trillion of federal debt held by the public. When these creditors are repaid, the dollars they receive will be worth less in real terms - to the benefit of Washington.

Dr. Eisner further notes that the deficit is now equivalent to only 3 percent of the total national output of goods and services, whereas it was about 6 percent a few years ago. Or 22.3 percent in 1945 right after World War II.

James J. O'Leary, an economic consultant to the United States Trust Company, argues that a ``more meaningful relationship'' is the net interest paid on the federal debt as a percent of gross national output (GNP) or of total federal outlays.

In 1945, he notes, this net interest was $3.8 billion, or 1.8 percent of GNP and 4.1 percent of total federal outlays. (Long-term bonds then cost the government only 2.5 percent.) In 1966, net interest amounted to 1.1 percent of GNP and 6.5 percent of federal outlays. But by last year net interest had grown to $152 billion, or about 3.1 percent of GNP and 14.3 percent of outlays.

Thus the budget has become more vulnerable to interest-rate shifts. ``If we should again experience anything like the rate rise of 1979-1982, inclusive, when three-month Treasury bills averaged 11.6 percent and long-term Treasury bonds about 12 percent, net interest would rise sharply and become a much higher percent of federal outlays and GNP,'' Dr. O'Leary warns.

He holds that a credible program to reduce the deficit meaningfully over a three- or four-year period is essential to remove the widespread fear that recurrent periods of high inflation and thus high interest rates are a way of life in the US economy. Without that progress, high real interest rates (after inflation) will hurt investment spending and economic growth.

These high rates will also encourage an inflow of foreign money into the US fixed-income markets (such as bonds), raise the dollar's value on the foreign-exchange markets, and thereby encourage imports and curb exports, says O'Leary. This will prolong the US international payments deficit.

But can the US count on foreign investors and central bankers continuing to invest their money into the US if the administration and Congress fail to trim the deficit adequately?

O'Leary thinks it is risky. The Federal Reserve System might be forced to increase interest rates to maintain the inflow of foreign money financing the US deficit. And those high rates could kick off a recession.

``We are in a dangerous period both from the standpoint of the US and the entire free-world economy,'' he says.

Edward Yardeni, a Prudential-Bache Securities economist, says such arguments are ``a bunch of nonsense.'' He says current low taxes stimulate prosperity.

``More people are earning more money. That helps to boost government revenues. Also it boosts savings, so wealth increases. As our wealth increases, so does our demand for financial assets including government bonds. Everyone is better off.''

Whether deficits are dangerous or not, the better part of valor would be a successful negotiation between President Bush and Congress on a budget package reducing the red ink.