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November 9, 1977



Charlie Schultze


Anti-inflation component of a 1978 economic
program, -

Without timely and vigorous Federal actions on a numbe
of fronts, the next several years are likely to see:

a stagnation of overall unemployment in the
6-1/2 percent area;


no improvement, and more likely a worsening of
unemployment for blacks and other minorities;


a continuation of inflation in the 6 to 6-1/2
percent neighborhood.


Economic growth and progress on the unemployment front
in the last half of 1977 is less than we had anticipated.
In 1978, without quick action on taxes, the CEA's forecast,
based on "realistic optimism" for sees a 4 percent growth
rate (fourth quarter to fourth quarter), and little further
improvement in the unemployment rate. An alternative forecast
based on "realistic pessimism" suggests that growth could be
as low as 3 to 3-1/2 percent, and that unemployment would
begin increasing. These forecasts raise the problem of how
to secure quick passage of the tax reductions needed to
speed up growth and improve the unemployment picture.
The problem of inflation complicates matters further.
We could, for awhile, deal with unemployment problems without
facing up to inflation. For a year, or perhaps two, inflation
might not get significantly worse. But if we are successful


on the unemployment front, then by mid-1979 or 1980, the
rate of inflation will begin to grow — and then it may be
too late to address it. Both economic and political
consequences would be severe. Unless the political
difficulties are absolutely insuperable, we must have
a meaningful anti-inflation program.


believe that the President should consider a comprehensive
economic program simultaneously aimed at all three problems.
But doing so — particularly in the case of an anti-inflation
program — requires:

a re-thinking of the components of the tax reform


a program of consultation with business, labor,
and Congressional leaders to see if the relatively
controversial parts of an anti-inflation program
had some chance of passage.

This memo is designed to lay out some options and to
suggest a program of consultations within and outside the
Administration. It differs, in some specifics, from
Barry Bosworth's attached memo, which explores antiinflationary options in some detail. But I think it
highlights the issues that I believe are most important.
Anti-inflation program

I think there are three basic options on inflation:

Do nothing.

The long-run consequences of this approach were
outlined above. It has the short-run advantage of not
rocking the boat and not getting in the way of our
pursuit of the other objectives.
Enunciate a series of voluntary guidelines or
standards for private wage and price behavior, and
be prepared to "jawbone" in important cases.
A set of voluntary guidelines and standards has
been developed by CEA and COWPS which would not rely
on rigid numerical guidelines for wages or prices.
Essentially the standards for wages and prices would
ask for a lower rate of increase this year than last
year, subject to specified exceptions.
(We call it a
"deceleration standard.")



There are few major union contracts coming up in
1978. Hence the guidelines would principally be addressed
to employers, in terms of both their price and their
wage decisions. If the guidelines worked, they would
hopefully set the stage for more moderate wage increases
in 1979 when the next round of major union bargaining
Such guidelines might be better than nothing. But
they have only a dubious chance of success. And they
are likely to involve the President occasionally, and
senior Administration officials more frequently, in
public confrontations with particular business or
labor leaders.


Use part of the tax bill as an explicit device
to secure moderation of wage and price increases in
We will need a tax reduction in 1978. Tax reductions,
like wage gains, increase workers' disposable incomes.
But unlike wage increases they do not add to costs and
prices. One way to secure wage and price moderation,
therefore, would be to use the tax cuts as an alternative
to wage and price increases. Specifically, we could
make permanent reduction effective in 1979, but also
offer a 1978 reduction along the following line (the
numbers and details are still illustrative, but in
the ballpark):

If an employer certifies that the wages and fringe
benefits of his employees (excluding governmentmandated increases) will increase by no more
than 6 percent in 1978 (fourth quarter 1977 to
fourth quarter 1978), each employee will receive
a 1978 tax reduction equal to 1-1/2 percent of
wages, up to wages of, say, $20,000.


For each 1 percent that an employer reduces his
weighted average price increase in 1978 below 1977,
he will receive a 1 percentage point reduction in
his 1978 corporate tax rate, up to, say, a maximum
of 2 percentage points.


This approach would provide economic stimulus and
also give strong incentives for wage and price moderation.
It would be entirely voluntary; no one is forced to "join."
The objective behind the approach is to break the momentum
of the current price-wage spiral in 1978, and lay the
groundwork for moderate union settlements and price
increases in 1979.
We have examined the administrative problems and most
of them seem manageable. We are now running calculations
of the likely fiscal, employment and inflation-reduction
consequences of various permutations of this approach.



It would give us a concrete, understandable, yet
voluntary approach to reducing inflation.


It would not require public jawboning of particular
price and wage decisions.


If successful, it would make it easier for the Fed
to pursue a lower interest rate policy — with lower
inflation the existing rate of growth in the money
supply would finance a larger growth in real output
and employment.


It would demonstrate the President's determination
to fight inflation, but do so in a way which also
promotes lower unemployment.


Except for those who favor full-scale price controls
or who want to fight inflation by keeping economic
growth low and unemployment high, no one can offer an
alternative which has any real teeth in it.


It is novel, "radical," untested, and would be


It would have to be incorporated as part of the
tax bill and its novelty might well delay passage
of the bill.



The amount of fiscal stimulus it provides would
depend on how many people chose to take advantage
of the offer. We can estimate the number, but
without any kind of precision.
(Many workers
would get lower wage increases anyway, and would
obviously join. Those expecting very high wage
increases wouldn't, since it wouldn't give them
enough to offset the wage loss. For a large
number in the middle, it would be a close


The Administration might be accused of proposing
a "gimmick."


Because it incorporates a specific wage standard,
the unions might say it was first cousin to the
old Kennedy-Johnson guideposts, which they do not


Unless it is quickly passed, its effectiveness
will diminish. For administrative reasons, we
have to make the wage and price standards apply
to calendar 1978. The longer that passage is
delayed the more difficult it becomes for employers
and workers whose wage increases are normally
made early in the year.
(They would have to make
contingent agreements.)


Even if we got wage and price moderation in 1978,
that doesn't guarantee its continuation into 1979.
(But it would surely help, and if it proved successful
a more modest version could conceivably be tried again
in 197S. If both wages and prices come down, everybody


It will seem unfair to many.
(Workers or firms
who had huge wage increases in 1977 and didn't
expect much in 1978 get a windfall; and vice-versa.)
But any deceleration of inflation has to be unfair,
since the inflation itself was not evenly distributed.

This kind of a proposal represents a major departure
from traditional policy. It would inevitably complicate
whatever tax program is decided upon. If proposed, it
would become a major element of the Administration's
economic program, and its elimination by the Congress would
be considered a major defeat.


But on substantive grounds this approach offers the
only hope for moderating inflation.
We will need Presidential approval to take some
soundings on the Hill and with the business and labor
community, to provide some basis for making judgments
about the idea. I believe we should see whether it has
any chance of success, even at some risk of leaks.

Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102