Offset The Defense Cutbacks Now

The end of the cold war should be welcome news, but it's bringing bad economic tidings. Defense cuts are already hitting far harder than most people expected, with 375,000 defense-related jobs lost since the beginning of the recession in July, 1990. If Congress and President Bush settle on slicing $75 billion out of the Pentagon budget over the next five years, the recovery is sure to be delayed, and it's likely to be disappointing when it comes.

That situation has a logical corollary: We need more expansionary monetary and fiscal policies to offset this drag on growth. The inflation risk is minimal, especially since defense has been one of the more inflationary sectors of the economy, with production regularly done on a cost-plus basis. With the defense sector shrinking and inflation trending down, the Federal Reserve need not hesitate to push interest rates still lower.

On the fiscal side, too, policymakers need to be bolder. They should recognize that spending and incentives have a role to play in mitigating the effect of defense cutbacks. Over the long run, the resources freed up should boost innovation, support new industries, create new jobs, and put the economy on a higher growth track. But the economy needs short-term help to make that transition. Real defense outlays could drop as much as 30% from their 1991 peak, removing an enormous source of fiscal stimulus to the economy. Lawmakers should push for more spending on infrastructure, education, and civilian research and development. Such spending would keep the economy growing in the short run and still be the right prescription for the country's long-term health.