GOP Counting On Windfall From Cutbacks : Budget: Economists, however, caution that the drop in interest rates predicted by congressional panels may not occur.

As they conduct their assault on the federal budget deficit, congressional Republicans are counting on an economic windfall from lower interest rates to help pay for tax relief, cushion the pain for some Americans who lose federal benefits and bolster the entire system of free enterprise.

Yet many economists caution that nobody really knows how far or fast interest rates would fall if the federal budget were balanced.

“We should be skeptical about particular numbers,” said Allan H. Meltzer, an economist at Carnegie Mellon University in Pittsburgh, Pa. “Much depends on how and where we cut--and how permanent the cuts are.”

If interest rates come down as far as Congress’ two budget committees are predicting, the government’s own borrowing costs would fall by $150 billion to $170 billion over the next seven years. Without the interest-rate windfall, the Republicans’ budget plans could topple like a house of cards.

In that event, the budget adopted last week by the House Budget Committee would still be substantially out of balance in the year 2002.

The budget accepted by the Senate Budget Committee, by contrast, does not count on the windfall to help achieve a balanced budget in 2002. But committee Chairman Pete V. Domenici (R-N.M.) said that when Congress actually puts into place the policies that would lead to a balanced budget, it could then count on the windfall to provide room to cut taxes.

Michael J. Boskin, a Stanford University economist who served as chief White House economist during the George Bush Administration, is among the many economists who are not so sure the windfall would materialize even then. “There’s a wide range of disagreement (over) how much the interest rates would come down,” he said.

Regardless of the impact on interest rates, most mainstream economists agree that America’s long-term prosperity depends on reducing the government’s addiction to red ink. There is considerable disagreement over the short-term impact, however, and some economists fear that aggressive budget-cutting--the two budget committees would slash spending by $1 trillion or more over the seven years ending in 2002--could throw the nation into recession.

“When you’re talking about withdrawing $1 trillion from total spending, that is going to slow the economy down. It has to,” said Robert Pollin, an economist at UC Riverside.

House Budget Committee Chairman John R. Kasich (R-Ohio), when asked about economists’ predictions of a recession, said: “We’ve invented economists to make astrologers look accurate.”

Kasich’s own prediction that interest rates will fall as deficits shrink is supported by economists at the Congressional Budget Office, who projected in a recent report that one hypothetical path to a balanced budget could push rates down by one or two percentage points.

In the CBO’s view, less demand for cash by the federal government would reduce the cost of borrowing, just as the price of tomatoes would fall if fewer consumers wanted to buy them.

In addition, Federal Reserve officials have hinted for years that they would reduce short-term interest rates to offset the possibly depressing economic effect of spending cuts as Congress put the budget on a path toward balance.

It is when these principles are reduced to dollars and cents that economists differ. If Congress makes good on its pledge to eliminate the deficit, how soon would interest rates fall? Which rates? And what would it mean for typical families?

“I’d think there are layers and levels of uncertainty here,” said Paul Krugman, a Stanford University economist. While interest rate reductions would be likely, he added, a particular forecast “is not something you’d want to take to the bank.”

Moreover, not all cuts have the same financial implications. “It will depend on the mix of spending cuts,” Meltzer said. “If we cut the budget by cutting highway maintenance, that’s not so much a cut as a postponement. We’re not going to let the highways crumble.”

The emergence of global markets for capital further complicates the picture, making events within U.S. borders less influential over the level of interest rates and the availability of credit than in the past.

For all the uncertainty, budget-cutters can cite studies of their own to back up their hopes for an economic windfall.

The CBO, for instance, suggested that the balanced-budget plan could reduce interest rates sufficiently to cut the government’s cost of borrowing by $145 billion over the next seven years. On top of that, $25 billion in additional tax revenue was projected to come from greater economic growth generated by the lower rates.

And a study by DRI-McGraw Hill found that 10 years from now, if interest rates fell by a “conservative” one percentage point because of budget-balancing, that would save the government $129 billion in that one year alone.

Still, there are doubters even in the conservative, cut-the-deficit camp.

“People are rightly cynical of rosy scenario budgets,” said Jeffrey A. Eisenach, president of the Progress & Freedom Foundation, a conservative group that recently announced its own plans to eliminate the deficit. For a deficit-cutting plan to earn credibility with the public, he continued, its economic assumptions “had better be very justified, very conservative and very well-explained to the American people.”