(FORTUNE Magazine) – IT IS 1995. The federal budget deficit is gone -- replaced by a budget surplus. The government has just paid off $101 billion of the national debt. Inflation, at 1.5%, is so insignificant that people no longer factor it into their financial plans . . . The pipe dream of some tweedy professor? A forecast for West Germany? No. These are the intentions of the U.S. government, set forth in black and white in the official budget document and in the congressional testimony of Federal Reserve officials. The Bush team, known more for its caretaker image than for vision, and the fussbudgets at the Fed have devised a bold economic program for the decade -- one radically different from anything America has experienced in a quarter century. Sure, you say, we've heard those kinds of promises before. The immediate outlook for both the deficit and inflation seems as grim as ever: The most recent inflation figures were climbing -- at a 6.5% annual rate in the first quarter -- and the Hydra-headed spendthrift who lives on Capitol Hill keeps pushing money out the door. There is also some question whether the new concepts have truly captured the President's imagination. In a recent talk with FORTUNE he made it clear that he is more concerned about promoting economic growth and job creation than he | is with reining in inflation. And while he said he is committed to running a budget surplus, it was hard to see much fire in his belly for the battle it will take. Subsequently, though, he did give the effort a boost by implicitly dropping his ''read my lips'' opposition to new taxes in his challenge to congressional leaders to forge a bipartisan deficit reduction package. The struggle ahead will pit the old politics of big government against the new ideas and the people who are committed to turning them into reality. The men around the President who support radical change -- call them the ''Bush radicals'' -- have one thing on their side: The ideas of moving toward budget surpluses and near-zero inflation are in fact much more realistic now than they were a year or two ago. New thinking is in the air, and a new set of policymakers wants to put it into practice. If the Bush radicals and the Fed should turn their plans into reality, just think of what it could mean. The 1990s could become a golden age for U.S. business and U.S. competitiveness. Interest rates might free-fall to levels not seen since the 1960s. National savings would climb, and America's dependence on foreign capital would be relegated to quaint memory. The Bush plan would move the budget into balance in 1993 and then build rising surpluses through the rest of the 1990s. These would be used to pay down the national debt. Says Michael J. Boskin, chairman of Bush's Council of Economic Advisers and point man for the radicals: ''It will take a lot of political acumen, as well as economic wisdom, to move in this direction. But we think it is a tremendously important change.'' The Bush team couldn't bring itself to use the word surplus in the budget documents. Instead, the Administration came up with a different set of accounts that shows, in effect, two budgets: one for the Social Security funds, the other for everything else. Thus the Bush budget envisions a balanced ''operating'' budget and treats the mounting surpluses in the Social Security funds as payments into something called ''The Social Security and Debt Reduction Fund.'' The reason for subterfuge is political. The idea of a balanced budget and the protection of Social Security just might be salable to the public. Something called a ''surplus'' would spur the already lively spending urge in Congress. Supporting this radical revolution is an unusually broad consensus that has jelled among economists in support of budget surpluses. The primary reason is that they see surpluses as the easiest way to boost America's anemic national savings rate and, hence, national investment. Lawrence Summers, the 35-year- old Harvard professor who was Michael Dukakis's top economic adviser during the campaign, favors a balanced budget and a surplus in Social Security. Says he: ''The consensus is shifting.'' Summers calls himself a mainstream Keynesian, but his opinions on the budget are shared widely throughout the academic community. Says Edward M. Gramlich, a professor at the University of Michigan: ''Something like three-quarters of the profession would support the goal of a surplus.'' Boskin is the chief evangelist for this consensus in the White House. Knowledgeable political observers see him shaping up as the most influential economic adviser in decades. Says Republican strategist Kevin Phillips: ''He's figured out a way to make George Bush like economics, and a senior official who can do that is automatically in reasonably good condition.'' Aides say Bush read an entire draft of the Economic Report of the President and took it seriously enough to suggest many changes. THE LAST TIME Washington saw such a convergence of academic ideas and influential advisers was in the Kennedy Administration. The idea then was that Washington could fine-tune the economy and tame the business cycle -- the ultimate application of Keynesian economics. Theory worked beautifully for a few years, only to malfunction in the inflationary spiral of the Vietnam war. The roller coaster of inflation and recession that was the 1970s produced sharp disagreements among economists and diminished expectations about what any policy could accomplish. In the 1980s, Ronald Reagan for the most part ignored his mainstream economic advisers. When Harvard professor Martin Feldstein, chairman of the Council of Economic Advisers from late 1982 to mid-1984, warned about the dangers of budget deficits, he was forced out. Reagan thought about abolishing the CEA, then pushed it to the periphery of policymaking. The only advice Reagan heeded was that which played to his instincts, notably for lower tax rates. With the change in the ideas and people has come a change in the economic and political realities. While Congressmen still rail about the ''ever- widening chasm of the budget deficit,'' the fact is that the deficit has been shrinking, both in dollars (from $221 billion in 1986 to $152 billion last year) and even more dramatically as a share of GNP. By that measure, last < year's deficit, at 3%, was less than half the 6.3% peak of 1983. So the Bush radicals have momentum on their side. Now comes the biggest prospective change in budget politics -- the collapse of Communism, and with it, the opportunity to reduce military spending significantly. The Bush budget provides $307 billion for defense in 1991, a 2% reduction after allowing for inflation. Congress is talking about cutting much more. By the end of the decade, geopolitics permitting, military spending could be at half its present level (see following story). Bush has said any peace dividend should go to deficit reduction, but he'll have a small war with Congress trying to make that stick. The nasty job will fall to Budget Director Richard Darman. Democrats like Senator Edward M. Kennedy want future military savings put into education, medical care, and housing. Conservatives as well as liberals think more should be spent on airports, highways, and other public needs. An old argument against running a budget surplus is that the fall in government spending would tip the economy into recession. Tighter fiscal policy would indeed tend to slow economic growth, but most experts think the U.S. is resilient enough to take the shift in stride. Their best argument comes from recent history: During 1987, when the budget deficit was cut sharply -- more than 1% of GNP -- growth continued and unemployment fell. In the Bush projections, the move from deficit to balance to surplus is much more gentle, never exceeding 0.6% of GNP a year. The Administration and many economists think that falling interest rates could easily offset this fiscal drag. Boskin cites two forces that would bring interest rates down. First, as the deficit is reduced each year, private borrowers would face less competition for funds. And as the government's program became increasingly credible, long-term borrowers would assess the implications of running budget surpluses and be satisfied with a lower return. OTHER ECONOMISTS doubt that the change in expectations would translate into lower rates. Herbert Stein, a senior fellow at the American Enterprise Institute and chairman of the CEA during the Nixon Administration, says, ''We've never created those conditions, and people are free to imagine anything they want.'' But he argues that even a $100 billion swing in the budget would have little effect on rates, since that's not much money relative to the total flow of investment around the world. < A test of Boskin's hypothesis could come soon. The battle over the 1991 budget, already brewing, marks the first time the Gramm-Rudman-Holling s law will have real teeth. The deficit target is $64 billion, meaning Congress and the Administration must come up with at least $45 billion in a combination of spending cuts and tax increases to avoid the automatic across-the-board budget reduction that the law requires. Congress, of course, could try to wriggle out by suspending or modifying the law. Were Bush to go along with such a stratagem, his fiscal credibility would be tarnished. The prospect of automatic cuts could scare both sides enough to seek a negotiated settlement. As Boskin puts it: ''We have said all along that we prefer to have a serious, rational, negotiated solution to the budget problems this country faces. But if necessary, we'll have to go to the end of the year and sequester again.'' Many well-informed observers are taking a Missourian's view of Bush's policies. Says Charles L. Schultze, a Brookings Institution economist who was Carter's CEA chairman: ''I don't believe them. The Administration has been making promises to the Congress for years, promising a balanced budget but never doing anything.'' Says Nobel Prize winner Milton Friedman: ''History shows, as much as history can show anything, which isn't much, that Congress will spend all the money it can lay its hands on.'' Still, there is some evidence that Congress is becoming more responsible. For all its shortcomings, Gramm-Rudman-Hollings has at least introduced the notion that spending increases must be paid for one way or another. Federal expenditures peaked as a percent of GNP in 1983 at 24.3% and have since declined to 22.2%. As ambitious as running a budget surplus is the idea of an America free of inflation. While FORTUNE expects inflation to rise this year, two good reasons for long-term optimism are, again, the people and the ideas. Federal Reserve officials have been emphasizing their determination to squeeze inflation from the 4% to 5% range it has been stuck in for seven years to near zero, and to do the job within five years or so. The code word here is ''price stability,'' understood to mean something between 1% and 2%. Federal Reserve Board Chairman Alan Greenspan has missed few opportunities to drum the notion into the heads of Congressmen. Two years ago, near-zero inflation was considered a fringe view among members of the Fed's chief policymaking group, the Federal Open Market Committee. But in recent months Fed officials have been endorsing the principle with an unusual degree of specificity. The best reason to take the Fed's intention seriously is its recent performance. Having held the inflation rate steady during the seven-year-old expansion is no mean feat: A spurt of rising prices has written finis to every major expansion since World War II (see chart). Says William A. Niskanen, chairman of the Cato Institute and a member of the Reagan CEA: ''The conduct of monetary policy for the past two years has been superb. The Fed is a much more credible institution than it was ten years ago.'' THE CONSENSUS among Fed officials is impressive. Observes Herbert Stein: ''We've had a lot of Federal Reserve chairmen sermonizing on inflation, but the idea of any kind of commitment by the Federal Reserve is pretty new.'' In February the presidents of the Federal Reserve banks of Cleveland, New York, Richmond, and San Francisco testified in support of a bill, sponsored by North Carolina Democrat Stephen Neal, that would order the Fed to achieve price stability within five years, and make it the Fed's No. 1 goal. Congress, of course, can't legislate lower inflation any more than it can raise the tides, but such a law would give the Fed some political cover if inflation fighting should lead to slow growth or recession. It might also help convince the markets that the government means business. Many economists hold that the Fed would have to provoke unemployment and recession to make real progress against inflation. That's what it took to get inflation down in the early 1980s, they say, and that's what it would take today. But a number of economists -- including some Fed policymakers and Bush's own advisers -- think the costs of lower inflation are exaggerated. One theory currently gaining ground is that the markets' expectations about future inflation help determine it. Individuals who expect 5% inflation expect 5% raises for starters. Investors want 5% on top of whatever else they demand. Thus, the more the Fed can convince Wall Street and Main Street of its seriousness, the further inflationary expectations, interest rates, and ultimately the inflation rate itself will fall. Pushed to its extreme, the expectational theory suggests ending inflation could be nearly painless. W. Lee Hoskins, president of the Cleveland Fed bank and the chief agitator for a price stability rule, puts the purist argument to groups of businessmen like this: ''Say I'm the policymaker and I have perfect credibility, and right now I say that we will move to zero inflation in five years and I ask you where interest rates will go. The answer is they'll go a lot lower and will do so very quickly. In fact, you won't even stick around for the rest of my speech. You'll be out buying bonds.'' So who's right? One problem with Hoskins's formulation is that no human has perfect credibility. Econometric models don't help much either. Those that merely predict the future based on the past project lots of pain in bringing down inflation. Those that incorporate expectational effects don't. In a sense it doesn't matter. Law or no law, Greenspan & Co. won't bet the country. As they have in the past, they will pursue a gradualist policy, testing the system, going further if it responds, pulling back if it doesn't. The Bush Administration's economic forecast assumes slight expectational benefits as the markets become believers: slow and steady improvement in inflation to 2.9% in 1995, with no increase in unemployment and no recession. LEE HOSKINS and other economists think the move toward zero inflation would ease the task of reducing the budget deficit by creating predictability and stability, and they urge that both goals be pursued at once. Keynesian economists agree that the twin goals could be met, but for different reasons. Janet L. Yellen, professor at the University of California at Berkeley, makes the case thus: ''The Fed has been saying for the past six years that as soon as the deficit is brought under control, they will be happy to bring down interest rates. They could still hit the same target, zero inflation, with more monetary ease than would be called for if the deficit targets aren't achieved. It would be tough to do, but there is no reason in principle that the two goals are mutually exclusive.'' The idea of an inflation-free America running big budget surpluses seems revolutionary only in comparison to the sorry Seventies and unbalanced Eighties. The America of the 1990s could be a different place: One with low interest rates and robust savings, investment, and exports. And in this game, as in the President's beloved horseshoes, even just getting close counts. Let's say inflation stayed up above 2.5% but we did manage to balance the budget. The U.S. would then enjoy the kind of balmy economic weather that has nurtured West Germany and Japan for much of the recent past. ^ For the first time in a long time, folks in the White House and the Fed are thinking big, and thinking long term. Now is the time to get rid of the policies that have made America the naughty child of the global economy, often scolded for its self-indulgent ways. The U.S. has the chance to put in place a macroeconomic policy suitable to a great power.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: CAN THEY REALLY DO IT? President Bush, shown here with Budget Director Richard Darman (left) and economic adviser Michael Boskin, says he is ''committed'' to having the deficit disappear in 1993.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: RISING INFLATION KILLS EXPANSIONS Previous expansions ran out of steam when prices spiked. One reason the good times of the 1980s have kept rolling is that the Fed has held inflation down.