Reagan Forecast of 3% Growth Contradicts the Fed : Economists See Fight Between White House and Central Bank as a Problem for Bush

The outgoing Reagan Administration, in a preview of what promises to be a continuing battle between the White House and the Federal Reserve over prospects for the economy, Tuesday issued a relatively optimistic forecast predicting that economic growth will advance at more than 3% a year for the next few years.

Fed officials, by contrast, warn that growth must be held between 2% and 2.5% for at least the next few years to prevent inflation from rising significantly.

Chief White House economist Beryl W. Sprinkel, acknowledging the difference between the Administration and the Fed, said: “One of us will have to correct his judgment about how fast the economy will grow.”

The forecast, which will form the economic assumptions underlying the budget that Reagan will present to Congress in January, also almost certainly will be used in developing President-elect George Bush’s initial economic program.

Reagan Administration officials are counting on a combination of healthy growth and declining interest rates over the next several years to bring down the federal budget deficit. Bush advisers already have acknowledged that his promise to curb the deficit without a tax increase depends on a similar coincidence of high growth and low interest rates.

The White House assumes, for example, that the rate on short-term Treasury bills will decline substantially from the current level of roughly 8% to 6.3% next year and 3% by 1994. Inflation, which has been averaging about 4% a year since 1982, is supposed to shrink to 1.5% by 1994.

But if the economy lives up to the Administration’s forecast and maintains a growth rate of more than 3%, Fed officials are likely to press for higher interest rates to head off inflation.

“If you allow the economy to expand much faster than 2.5% and productivity doesn’t improve significantly, you are probably running some risks on the inflation side,” said Gary Stern, president of the Federal Reserve Bank of Minneapolis and a member of the Fed’s policy-making Open Market Committee.

And if growth slows to the pace the Fed considers sustainable, it will be that much harder for Bush to reach his deficit goals.

“It is going to require either fiscal or monetary restraint to hold growth down to tolerable limits,” said Lyle E. Gramley, a former Fed governor who is now chief economist of the Mortgage Bankers Assn. “So if Bush is counting on both stronger growth and lower interest rates to escape having to deal with the deficit, he is going to be disappointed.”

Some conservative economists worry that the Fed’s concern over excessive growth could undermine Bush’s presidency.

“What is unique about today’s national debt is . . . the steep interest rates taxpayers still have to pay to service the debt,” said Alan Reynolds, chief economist at Polyconomics Inc., in Morristown, N.J.

“Except for interest expense, the U.S. budget is already in balance. Any serious budget strategy can scarely afford to simply hope the Fed will do better in the future than it has in the past, without any guidance, mandate or performance standards from the Administration.”

Sprinkel, whose replacement in the Bush Administration is expected to be Stanford economist Michael J. Boskin, said the White House and the Fed share the “objective of sustained economic growth and price stability.”

He dismissed the possibility of any immediate conflict, partly because the White House forecast for next year’s economy, disregarding distortions caused by last summer’s drought in the farm states, is a more modest 2.8%. In contrast to the wide disparity between the longer-run projections, that forecast is relatively close to the Fed’s expectations.

“There will be a tendency to call this a rosy forecast, but I don’t consider it very rosy,” Sprinkel said.

White House and Fed forecasts for economic growth next year are complicated by last summer’s drought. The sharp decline in farm inventories shaved an estimated 0.7 percentage point off growth this year, to about 2.6% from the 3.3% gain the economy would have achieved without the drought.

The Administration is projecting that the economy will make up in 1989 for the growth lost to the drought in 1988. Thus, its estimated 3.5% growth next year includes the lost 0.7 percentage point. Without that, projected growth in 1989 would be a more moderate 2.8%.

LOOKING TO THE FUTURE

Following are the Reagan Administration’s 1988-94 forecasts, in percent, for gross national product growth, the average unemployment rate, the consumer price index and the 10-year Treasury note yield:

GNP Unemployment CPI 10-year yield 1988 2.6 5.4 4.3 8.8 1989 3.5 5.2 3.7 8.3 1990 3.4 5.1 3.5 7.3 1991 3.3 5.0 3.0 6.0 1992 3.2 5.0 2.5 5.0 1993 3.2 5.0 2.0 4.5 1994 3.2 5.0 1.5 4.0

Source: President’s Council of Economic Advisers