The cornerstone of the Carter administration's anti-inflation policy is to create significant slack in the American economy and keep it there long enough to bring down inflation.
Some other actions, such as stimulating business investment, are also part of the strategy laid out in the president's annual economic report released yesterday, but slower economic growth and higher unemployment are the key to both the short-run and long-run attack on rising prices.
The most immediate problem, according to Charles Schultze, chairman of the Council of Economic Advisors, is to keep last year's energy-led inflation from spilling over into bigger wage increases in 1980.
To that end, the administration is prescribing a tight budget with no tax cuts despite a more-than-$40-billion increase in real tax burdens of individuals and business in fiscal 1981 which begins Oct. 1. And the economic report speaks approvingly of the Federal Reserve Board's monetary policy that has pushed interest rates to record levels.
Those policies, along with the impact of higher oil prices on the economy -- termed "oil drag" in the report -- will produce a mild recession in 1980 with unemployment rising to 7.5 percent by the fourth quarter, the report predicts. In December the rate was 5.9 percent.
Moreover, in 1981 economic growth will be only 2.8 percent, fast enough to trim only about 0.2 percentage points off that unemployment rate, the report indicates.
Deliberately seeking to maintain that amount of unused productive capacity -- both people and machines -- is unprecedented in postwar history.
But it is a measure of the seriousness of the inflation that President Carter would propose such a policy in an election year.
If the policy does work in the short run to prevent that spillwork of last year's inflation into this year's wage increases, the amount of slack the policy envisages will not, the report said, mean a quick end to inflation.
"In the present environment we cannot realistically expect that price and wage increases will respond quickly and strongly to a moderate increase in the degree of a slack in the economy," the report said. "Nor can it be expected that a sharp but relatively short recession would have a lasting effect on inflation. Expectatios of inflation have become much too deeply entrenched for that to happen."
Inflation is "a 10-year, a 12-year problem," Schultze told reporters.
And over those years, the demand for goods and services in the economy will have to be restrained compared to what could safely be tolerated if inflation were low, administration economists said.
During the years ahead, while holding down growth eases inflationary pressures, the administration would seek to speed the inflation unwinding process by using some form of an incomes policy -- such as its present voluntary wage-price standards program -- while also continuing its efforts to ease the burden of government regulations on business and encouraging investment and savings.
This week administration policymakers are trying to decide whether to accept the recommendations of its pay advisory committee for the 1980 pay standard. Top officials are expected to make up their minds today or tomorrow whether to go along with the committee's proposal of a 7.5 percent to 9.5 percent range, or to tighten it by stressing the midpoint of the range, in effect creating an 8.5 percent standard.
Any tightening of the committee's recommendation could lead to a walkout of the six labor members, including AFL-CIO president Lane Kirkland. Such a walkout could jeopardize using the pay committee apparatus and the standards in 1981 when economic circumstances might again allow an attempt to set a standard that would lead to a deceleration of wage increases and thus a lower inflation rate, officials said.
During the next two years, administration economists are hopeful inflationary expectations will be cooled by another development: a decline in the reported rate of inflation as measured by the consumer price index.
Last year the rate was 13.3 percent. The administration forecasts it will drop to 10.4 percent in 1980. But the improvement will be due to a smaller increase in energy and housing prices and lower mortgage interest rates. The portion of the index other than food, energy and housing may actually rise faster in 1980 than 1979, officials said.
The report predicts the CPI will rise only 8.6 percent in 1981, with much of the further drop also due to slower inflation in those three volatile areas. That forecast assumes world oil prices will rise in line with inflation this year, and only slightly more than that in 1981.
However, inflation as measured by the GNP deflator, a broader index than the CPI, would be little changed in 1980 or 1981, according to the report.
But since the CPI is much more widely followed, and is the basis for most cost-of-living adjustments in labor contracts, officials hope there will be a sense of a slowing of inflation. In the context of higher unemployment and a growing feeling government is determined to "stay the course" with its anti-inflation policies, officials hope inflationary expectations will be lowered.
CEA's Schultze firmly rejected the alternative approach suggested this week by Sen. Edward Kennedy (D-Mass.), Carter's rival for the Democratic nomination for president. Kennedy sharply criticized the president's record on inflation ad proposed a six-month "freeze on inflation" followed by mandatory controls on wages, prices, profits, dividends and rents.
Would controls be a good idea? Schultze was asked.
"Dear God, no," he exclaimed. "I do not think wage and price controls are the answer.In fact, I think they are likely to do more harm than good."
Controls cannot hold down inflation for any period of time, Schultze argued, declaring, "It's a 10-year, a 12-year problem . . . Buying six months just fools people."