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March 15, 1978


W. Michael BlumenthalJ,
Charlie Schultze ' U i


Price Prospects and Anti-Inflation Initiatives

Earlier this week the CEA sent you a background
memorandum on inflation.
At the Cabinet meeting on
March 6 , Secretary Blumenthal stressed that the inflation
situation is worsening.
This memorandum outlines our
present expectations for prices in 1978 and sets forth
a series of policy options for invigorating the anti­
inflation program.
The specific policy options outlined below have not
yet been cleared with all EPG members, but the general
ideas expressed in this memorandum were discussed at
a recent EPG meeting.
We would, therefore, want to get
together with you as soon as possible to discuss the
inflation problem and what should be done about it.

Recent Price Developments
The price outlook is deteriorating.
Weather influences
contributed to some of the sharp rise in consumer food prices
in January.
But a more fundamental worsening of the outlook
also appears to be underway.
In preparing for the Budget and Economic Message this
year, the interagency forecasting team balanced two offsetting


An acceleration in the underlying rate of inflation
based mainly on higher payroll costs due to
(i) increased employer social security taxes,
and (ii) higher minimum wages.


An expected slower growth in farm and food prices.

-2The underlying rate of inflation was expected to be in the
6-1/2 to 6-3/4 percent range, but with food prices rising
moderately, the overall consumer price index was forecast
to rise by 6 to 6-1/4 percent, fourth quarter 1977 to
fourth quarter 1978.
Since these estimates were put together, a number of
developments have all moved in the direction of increasing
the prospective rate of inflation.

Food prices will probably rise more than forecast.
Whereas the forecast had included a rise in the
food component of the CPI of about 4-1/2 percent
(QIV to QI V ) , we would now expect an increase of
around 5-1/2 percent, or possibly more.
would add about 0 . 2 percentage point to the overall
price increase in 1978.


The forecast made no allowance for the price
effects in 1978 of depreciation of the doll a r .
Allowance for this might result in a rise of
prices of about half of 1 percent by the end
of the year, assuming no further depreciation.


Average hourly earnings are creeping up.
are now rising at about one-half percent faster
than a year ago.
Moreover, the higher wage
costs in the coal settlement, as they carry
forward into industrial and residential utility
rates and steel production costs, would add to
overall prices.
Unit labor costs will rise
somewhat more than expected.


The forecast had incorporated the National
Energy Plan, which would have yielded a 0.2
percent rise in overall prices as a result of
the crude oil equalization tax.
The likely
compromise on natural gas deregulation may
increase energy prices somewhat more, but how
much is not clear at this time.

Overall, it appears that consumer prices might rise
about 1 percent more than had been expected, bringing
the increase in the CPI during 1978 to the 7 to 7-1/4
percent range.

-3There is considerable risk that prices may rise even
faster than this.
For example, the new estimate does
not assume any OPEC price increase in response to the
changing value of the dollar, nor does it assume further
adverse weather conditions here or abroad, nor a marked
acceleration in unit labor costs, nor ripple effects of
the coal settlement on other wage negotiations.
Rising inflation and inflationary expectations are
already working on financial markets, domestic and
They are contributing to the continued
weakness of the dollar and the stock market.
Inflation would, by now, have been reflected more
strongly in interest rates, were it not for the relatively
calm behavior of the monetary aggregates in recent weeks.
As it is, the rise in market interest rates has already
begun to reduce savings inflows to thrift institutions,
and the thrifts have begun to trim new mortgage lending
A continued rapid rise in prices will convince market
participants that monetary tightening is in prospect,
whatever the course of the monetary aggregates.
conviction could push interest rates up further, even
without Fed action.
Moreover, it is doubtful that the
Fed would resist reinforcing the market's response in the
event of further price acceleration.
In sum, absent other convincing anti-inflation programs,
the classic resolution of the inflation problem is likely
to take the form of tightening financial markets, even with
the Federal Reserve lagging rather than leading the market.

Anti-Inflation Initiatives
In light of these price developments and potential
consequences, we believe that it is imperative that you
act decisively to focus greater'attention on the anti­
inflation program. We recommend an announcement of a
series of actions that would demonstrate your concern and
commitment to achieving progress against inflation.
is important that these actions go beyond exhortation;
they must have a direct impact on prices and wages.




A voluntary restraint program cannot be effective
unless it has your visible support and backup by
all Cabinet-level officers.



The deceleration program will not be credible
unless the government acts within its own areas of
responsibility to initiate a deceleration.

It is necessary that developments in the coal
situation do not set a pattern for future wage
and price behavior.

Immediate Action

We propose that the following items be the basis for a
Presidential announcement on inflation, perhaps at the opening
of a press conference.

1. You could announce that the Federal government
will assure that there is a significant deceleration
in the magnitude of Federal pay increases.
The 1976 increase was 5 percent;
increase was 7 percent.

the 1977

Federal employees have not been impacted by
the recent large increase in social security
Deceleration would therefore not be
a major burden on them.
Federal wage rate adjustments are believed
to have a substantial impact on local labor
This action would be well received by the
public, but may anger Federal workers and
could reduce their support for Civil Service
2. You could ask state and local government officials
to follow the lead of the Federal government with
respect to wage rate increases, and to cooperate
further by reducing sales and property taxes where
These government actions on wages would have a
strong impact on nonunion wage increases
throughout the economy.
They will probably upset organized labor.



3. You could request the support of public utility
commissions and the independent regulatory agencies
in the deceleration objective.
This may irritate a few members of Congress who
object to Executive Branch involvement with the
independent agencies.
It may lengthen the regulatory delay on rate
4. You could announce that your Executive Order on
Improving Government Regulation will be issued the
following day.
This program has been delayed for three months,
but is ready if your approval were given.
It would be received very positively by the
business community.
At the same time, you could announce that you
are meeting personally with the heads of the
executive regulatory agencies to impress on
them the importance of assuring that new
regulations are necessary and that they are
5. You could emphasize the importance of moderating
increases in hospital costs and ask the Congress
to act immediately on your hospital cost contain­
ment and capital budgeting program.

. You could instruct Federal procurement officers
to avoid or delay purchase of those goods whose
prices are rising rapidly.
Such a directive is not unprecedented, but
care would have to be taken to avoid conflict
with other objectives of procurement policies.

7. You could direct your advisors and heads of the
affected agencies to develop a program, and report
back to you within a month, for an early resolution
of Federal policies toward wilderness a r e a s , to
expand the lumber supply from Federal lands. Lumber
prices have been a very rapidly rising component
of housing costs (17.9 percent in the last year).

-6 -

While this would be a controversial action with
environmentalists, it is believed that an expansion
of timber harvest from Federal lands could be
achieved without damaging environmental or other
multiple-use objectives.
Any public announcement should be preceded by
consultation with Secretary Bergland.

. You could follow up these actions by calling separate
meetings with businessmen and labor leaders to ask
them to reduce the rate of their price and wage rate
increases, including increases in "highly visible"
executive pay.
This would emphasize the deceleration principle
at the level of individual decisions in the
private sector.
Cabinet-level officials and CWPS staff could
follow up with meetings with individual firms,
large employers and labor union leaders.


Future Administration Decisions

If you decide to press the anti-inflation program,
inflation concerns will be a major issue in several future
Thus, it is important that you be aware of the
implications of highlighting the inflation issue.

Farm Legislation
Any future actions to respond to the farm strike
by raising price supports, reducing production,
or restricting imports will have an immediate
impact on prices.
National Health Insurance
The financing and cost incentive aspects of
any proposal could have major inflationary
Welfare Reform
The Administration is under pressure to raise
the wage rate for public service jobs.
will impact on the lower range of local wage

-7Trade Restrictions
Currently, requests are before the ITC or
STR for trade restrictions on copper, CB
radios, zinc, and special steel products.
The steel industry has pushed for an upward
revision of the steel reference prices.
The MTN trade negotiations have major price
implications as domestic industries push
for exemption from tariff reductions.
Regulatory Actions
The Administration will be making decisions on
regulatory actions and legislation during 1978
with very significant potential for cost and
price increases.
Social Security Legislation
A number of proposals are coming up in the
Congress to restructure social security
financing in order to mitigate the tax
increases recently enacted.
Some would have
anti-inflationary benefits; others would not.
The relation of reductions in social security
taxation to the objectives of the tax reduction
and reform program have to be considered carefully.
III. Actions in Specific Sectors
We are in the process of developing a specific list
of economic sectors in which we will concentrate our
efforts over the next year to reduce inflationary pressures.
Interagency task forces would be established to examine
alternative strategies for altering price-cost behavior
in those industries where we feel that government participation
can make a difference.
These areas would include the primary
metals industries, transportation, medical care, housing and
We could implement our prior plans to meet with
individual firms and unions to emphasize the deceleration
objectives and to monitor their performance.


We could examine the merits of Administration
support for no fault insurance.



OMB could be asked to set up a special unit to
develop procedures for establishing a "regulatory
budget" that would measure the costs entailed in
achieving the social objectives of regulation.
Consideration could be given to the subsequent
creation of a Congressional/Executive Branch
commission for joint actions in this area.

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