Model from a US economist says deficits will heat up inflation
Michael J. Hamburger, an economist in the Office of Management and Budget, sounded a touch surprised. ''The model, unfortunately, is doing spectacularly well in 1983,'' he said. Mr. Hamburger was referring to an econometric model he and Burton Zwick of the Prudential Insurance Company of America devised several years ago to explore the question ''Are deficits in the federal government's budget inflationary?''
The basic conclusion drawn from the model is that, yes, deficits do result in more inflation.
And, partly because of that research, Hamburger expects higher inflation next year - 6 or 7 percent - and real growth in the economy of about 4 or 5 percent.
These numbers, he emphasized, are his ''personal forecast.'' But they will likely be considered as the Reagan administration in the next few weeks decides on an official forecast. That is normally put together at a meeting of the ''troika'' - the chairman of the Council of Economic Advisers (Martin Feldstein) , the secretary of the Treasury (Donald Regan), and the director of the Office of Management and Budget (David A. Stockman).
Last year, Dr. Feldstein insisted that the official forecast be cautious rather than rosy. He prevailed in the troika, but the recovery turned out to be normally robust.
This year Dr. Feldstein, on leave from Harvard University, may have a harder time selling his viewpoint, should it differ from that of the Treasury or OMB (assuming Dr. Feldstein is not ousted from office as a result of his open criticism of budget deficits).
But back to the model, which is a mathematical way of using the past record of the behavior of the economy to predict the future: Mr. Hamburger is an economist of the monetarist school. Thus he maintains that a too-rapid growth in the nation's money supply will, with a lag of a year or two, produce faster inflation. He reckons that deficits are important to the economy not so much for themselves, but because they are to some degree financed by the Federal Reserve System. The Fed buys some outstanding Treasury bonds, notes, or bills from the public, thereby helping the Treasury to finance excess government spending. The checks the Fed writes to buy these debts are deposited by the public in banks, and thus become part of the nation's money supply, which consists of checkable accounts plus currency in circulation. If there is more money around, it allows not only faster real growth in the output of goods and services but, with a lag, greater inflation.
The model examines whether, when deficits rise or fall, the amount of Fed financing also rises or falls. And it does - with the exception of 1975, 1976, and 1982. That means the Fed doesn't have to create extra money to help finance the deficits. But it does as a rule. The Federal Reserve probably didn't always make a conscious decision to help out the Treasury by printing a little extra money. It was often because the Fed tried to stabilize interest rates, and the upward pressure of financing needs on rates prompted the Fed to buy more government paper.
Using deficit projections, the model can be used to predict growth in money (M-1). That number can then be used separately to forecast growth in the output of goods and services and inflation.
Although the model is based on statistics from about a decade ago, it predicts M-1 growth this year of 10.7 percent - which is about what it's turning out to be.
''There are people who feel uncomfortable with (the model's) approach,'' Hamburger admitted. ''But we are not talking about the behavior of an individual. We are talking about institutions.''
In other words, he is arguing that the group of 12 people making up the monetary policymaking body of the Fed, the Federal Open Market Committee, act more predictably than one individual might.
Because of the huge deficits anticipated in the years ahead, the model foresees even faster money growth in 1984 and '85, and thus, in effect, even more rapid inflation.
As Hamburger admits, however, ''If the Fed deviates from the past, then there is some hope.'' Right now, in fact, the Federal Reserve is being so stringent in its creation of money after creating money at a record rate earlier in the year that some economists are concerned about the possibility of a sharp slowdown in the economy or recession in the last half of 1984.
Looking at the numbers in some technical detail, Hamburger concludes there is ''hope for no recession.'' He would be delighted to have the Fed continue a pattern of slower money growth (but not overdo it) and make his model fail next year. It would mean continuation of a moderate recovery without accelerating inflation.