The world's finance ministers who met in Washington this week have reportedly urged tighter monetary policies to combat the inflation they expect from the recent doubling of oil prices.
While that may make sense for the strong economies in Europe and Japan, it is wrong for the United States, which is now almost certainly in a recession.For the United States, accepting the finance ministers' prescriptions would mean following the same course that proved so disastrous after the 1973 and 1979 oil price rises. Those actions - in essence, a tight-money policy combined with a moderately loose fiscal policy - led directly to the recessions of 1974-75 and 1981-82.
This time the results could be even worse. Never before have we headed into a recession with a budget deficit as high as 5 percent of gross national product.
A bad slump, along the lines of those of 1974-75 and 1981-82, could balloon the deficit into the $300 billion to $400 billion range. The United States has never had to finance amounts such as these.
Further, with Germany struggling to pay for unification and Japan's financial markets weakening, we no longer can count on huge inflows of foreign capital to finance our deficits as we did in the '80s. And corporate debt is dangerously high.
Currently, American corporations devote approximately 50 percent of their earnings - a historic high - to meeting interest payments. Thus, a recession could send bankruptcy rates soaring over the next year, with big job losses.
Finally, the government lacks the traditional, Keynesian tools to fight a recession. Previously, Washington would try to revive a slowing economy with lower taxes and higher spending. Today's large deficits rule this out. Financial markets would panic if it were tried.
In short, we cannot afford to let this recession deepen.
If nothing else we should at least try to avoid the mistakes of the Carter years. After the Iran oil embargo of 1979, the Carter administration followed a status-quo economic policy. With the economy sluggish, no effort was made to tighten fiscal policy.
Into this vacuum stepped the Federal Reserve System, slamming on the monetary brakes to reduce demand and, ostensibly, to suppress oil-driven inflation. The result, however, was to severely deepen the recessionary influences that already had been set in motion.
The key point is this: In today's weak economy we can't cure the inflation of an oil shock by tightening money. That would just squeeze demand, guaranteeing a longer recession.
It is better to accept some temporary inflation from the oil shock than slam on the brakes and throw the economy into a dive.
The only way to stimulate the current economy is to lower interest rates sharply.
Fed Chairman Alan Greenspan has predicted that a credible budget deal could lead to rate reductions of two full percentage points. This stimulus would easily offset the fiscal drag of a tighter budget.
Since the invasion of Kuwait, the economy has dropped like a stone. Consumers and businesses, recalling the earlier oil shocks, are retrenching, cutting back purchases in anticipation of a steeper downturn. Retail sales have run into a wall.
This economic fallout from the two earlier oil shocks drove Presidents Ford and Carter from office and many congressmen with them. Bush's war-driven approval ratings notwithstanding, the same thing can happen again.
(Roger C. Altman, assistant secretary of the treasury from 1977 to 1980, is vice-chairman of the Blackstone Group Inc.)