Budget Plan Seen Having Limited Impact on Economy : Deficit: Experts say size of cuts will not allow for significantly lower interest rates. They still predict a slowdown, bordering on a recession, for end of year.
The budget and tax package finally emerging from Washington is likely to have only a marginal impact on the outlook for the national economy, which already may be slipping into a recession, economists said Friday.
The relatively small budget cuts scheduled in the first year of the five-year, $500-billion deficit-reduction package should provide the Federal Reserve Board with enough flexibility to ease up on interest rates, but only by about one-quarter of a percentage point, analysts said.
While helpful, a rate cut that small would be unlikely to spur the economy in a significant way. In fact, many analysts now expect the economy to stop growing sometime during the final three months of 1990, with growth unlikely to resume until the second half of 1991.
Analysts note that the higher taxes included in the package, along with the proposed cuts in government spending, will act to dampen the economy. That, in turn, may more than offset any short-term gains provided by lower interest rates.
While the financial markets may react positively to the agreement in the short term, the net effect for the overall economy is expected to be modest.
“The main economic effect will be a little further slowing, but it does so little that this is really peanuts,” said Charles L. Schultze, an economist at the Brookings Institution and a former presidential budget director.
“The changes, especially in tax policy, are not so significant as to have a major impact on the economy,” added Michael Cox, economic adviser to the president of the Federal Reserve Bank of Dallas. “The only big effect I see is that, by continually changing tax policies, Washington is making it harder and harder for businesses and individuals to plan ahead, and that can depress economic activity.”
Economic forecasters said the new budget and tax changes would not alter their predictions of an economic slowdown, bordering on a recession, beginning in the final quarter of 1990 and continuing through the first half of 1991.
At DRI-McGraw Hill, a forecasting firm based in Lexington, Mass., for instance, some budget-cutting already had been factored into a predicted 1.3% fourth-quarter decline in the gross national product. The firm expects no change in the first quarter of 1991, and only 0.8% growth in the second quarter of next year.
“It’s a pretty small percentage of the economy that you are talking about cutting,” noted Cynthia Latta, an economist at DRI-McGraw Hill. The budget cuts and tax hikes “will show up somewhere in slower growth, but it is going to be very hard to distinguish their effects from the general slowdown that we are already in. Their impact may just look like part of the broader slowdown in the economy.”
Still, analysts said a failure by Congress and the White House to reach a budget agreement would be much worse for the economy. And they noted that a willingness to deal with the deficit more directly is important, especially because the new package comes without the “smoke and mirrors” used in previous years to hide the true size of the deficit.
“It’s not that big a package, and I don’t think it is going to have a very big impact in the grand scheme of things, but it is still nice to have,” observed Herbert Stein, an economist at the American Enterprise Institute in Washington. “It is good to have broken the sound barrier in Washington on certain things that now can be cut, that couldn’t before, like Medicare.”
Other economists warned, however, that the federal deficit remains likely to hit a record high in fiscal 1991 of $250 billion to $300 billion, up from $220 billion in 1990, largely because the economic slowdown will cause a decline in tax revenues.
“The tax increases are real enough, but their effect on the overall economy may not be great because we are still going to have big deficits,” said James Solloway, chief economist at Argus Research, a New York investment research firm. “So the actual numbers may not have an impact, although I think the higher taxes will hurt consumer confidence.”
In fact, the Conference Board, a New York business research firm, plans to report on Monday that its survey of consumer confidence showed its biggest one-month drop on record in October. The group blamed at least part of the decline on the endless wrangling in Washington over the budget.
“So I think consumers will cut back on spending as a result,” worsening the downturn, Solloway said.
