TO SHOW how much times have changed from the days when we all talked about how to keep the inflation genie bottled up, news that core consumer prices (excluding food and energy) jumped in May brought sighs of relief from investors and policymakers. No longer spooked by fears of inflation, they were worried that the deflation disease was about to spread from Japan to the United States. It hasn't. So plans only half-jokingly mooted by Federal Reserve Board officials to ward off deflation by dropping newly printed dollars from helicopters have now been put on hold, although the possibility of a preemptive cut in interest rates tomorrow remains on the table.

Times have also changed in the area of fiscal policy. Chanting "We are all Keynesians now," investors are cheering congressional approval of President Bush's tax cuts. Recall the bidding: Bush asked for $725 billion in cuts over ten years. Congress gave him only $350 billion. Or so it seemed, until wiser heads pointed out that many of the cuts are due to expire in a few years--unless, of course, Congress renews them. Which it inevitably will, bringing the total ten-year reduction close to $1 trillion.

That should worry investors and businessmen familiar with the books and articles written by White House economists before joining the administration. When ensconced in their ivory towers, they contended that substantial deficits eventually stifle growth by forcing long-term interest rates up. That proposition is borne out by a new report by the Fed that finds that every one percentage point increase in the ratio of the federal deficit to the nation's output of goods and services (GDP) will lead to a one-quarter of a point rise in long-term interest rates.

Since the federal budget has swung from a surplus of 1 percent of GDP to a deficit of 4 percent--a 5 point swing--long-term rates should be 1.25 percent higher than they otherwise would be. And that's on top of any increase that should occur as the economy recovers.

But why be churlish? That pain is down the road. Last week I suggested that all the American economy needs in order to return to a more satisfactory growth pattern is a cut in oil prices. I may have been wrong. The recovery may be gaining momentum even with oil prices stuck at their present level.

Right now, and for the future period that matters in Washington (from now until the November elections) things are looking up. The index of leading economic indicators is rising, the service sector continues to grow, and the manufacturing sector is on the mend. Industrial production edged up in May, with high technology products leading the way. The New York Fed's index of manufacturing conditions in the state jumped in June, and the Fed's index of activity in the mid-Atlantic region also rose.

Even pessimists now agree that things have stopped getting worse, and are probably getting better. The National Association of Manufacturers, described by BusinessWeek as "normally gloomy Gusses," now thinks that "the economy is at a turning point," and is predicting that growth will reach an annual rate of 3.9 percent in the second half.

No wonder. Profits and cash flow are on the rise, with the Department of Commerce reporting that first quarter earnings of domestic companies rose 10 percent in the first quarter. And the reduction in the cost of capital brought about by rising share prices and falling interest rates, probably means that the long drought in business investment is coming to an end.

Even the financial services sector may be in for better days. Securities firms have cut 80,000 jobs in the past two years, but nervous brokers and investment bankers are now taking heart in the fact that the market for initial public offerings is showing a bit of life, merger and acquisition activity is reviving, trading volumes and share prices are moving smartly up, and investors are pouring money into equity mutual funds at the fastest pace in over a year.

A sign that the uptick is expected to continue is the $1.825 million paid for a seat on the New York Stock Exchange last week, 22 percent more than a seat went for in March. A less reliable but equally cheery sign is the Wall Street Journal report that corporate customers have thrown 10 percent to 20 percent more parties in a Wall Street-area champagne bar in the past month, and that the high-end bubbly brands are now replacing the more austere ones.

Meanwhile, consumers continue to do their share, and more, to keep the economy on track, rolling up debt in the process. In part because the first round of tax cuts is now reflected in pay checks, real after-tax incomes have risen by 2.4 percent in the past 12 months. And in a few weeks the latest round of Bush tax cuts will begin to reach consumers' wallets and pocketbooks.

Goldman Sachs's economists estimate that this added cash might boost real GDP by 1 percentage point over the next 12 months, but warn that this growth might not eventuate because "the skewed distributional impact"--read: most of the money goes to high earners--might "translate into a low propensity to spend the extra dollars."

Perhaps. But one sure thing is that the housing market will continue to attract consumers' dollars. The Mortgage Bankers Association reports that record-low mortgage rates (4.99 percent on the typical fixed-rate, 30-year loan) are increasing requests for mortgages, and the government reports that housing starts rose 6.1 percent last month.

But every silver lining has a cloud, and right now it is the weak job market. Productivity improvements permit employers to expand output without increasing manning levels, and to continue layoffs in several industries. But consumers nevertheless keep spending, and polls show that they are more optimistic about the future than was the case in past recessions. Unless they turn suddenly gloomy, unlikely with the tax cuts boosting incomes, the economy seems headed for pretty good gains by year end.

Irwin M. Stelzer is director of regulatory studies at the Hudson Institute, a columnist for the Sunday Times (London), a contributing editor to The Weekly Standard, and a contributing writer to The Daily Standard.

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