The onset of the seventh postwar recession is bound to trigger renewed demands for government action to get us out of our current economic fix.
The distress signs are everywhere. Unemployment is now 7.8 percent -- far above the 5.7 to 6.2 percent that prevailed in 1979 and early 1980 -- and probably will go higher. Inflation remains at double-digit levels, and even optimists do not see it going much below 8 or 9 percent soon.
But we are fooling ourselves if we think government can soon mend our economic machine. What matters now is getting the basic issue straight. That issue is not this month's or next month's unemployment rate; rather, it is whether the economy can resume growth without intensifying inflation.
For the past 20 years, we have increased jobs by increasing inflation and have fought inflation -- ineffectively -- by reducing jobs. We need to halt that pattern.
Military analogies suggest themselves. In the 1960s, we had an economic strategy that survived into the 1970s. The idea was to keep the economy operating with "full employment," with government giving it a helpful push whenever it slipped. Anti-inflationary policies were short-lived, because the government reacted so quickly to any conspicuous slowdown that, once economic growth restarted, inflation rose above previous levels.
If this happens now, we will probably start the next expansion at a 9 or 10 percent inflation rate. So the government needs a new stragegy. Because it can not effectively push the economy where it wants, it should not try. Government ought to balance the budget, assuming a reasonably high level of employment. And it ought to reduce money supply growth, providing enough money supply growth, providing enough money to finance expansion but not inflation. Aganst that backdrop, the private economy will generate jobs.
Three things are worth remembering in the forthcoming economic debate.
First, even in recession, the U.S. economy provides jobs and prosperity for most people. This is not said as a cruel joke even though many unemployed endure genunie hardship, and fear of job loss causes mental stress for many others.
But our economic rhetoric has acquired an unreal, childlike quality, suggesting that everything is bad and someone better make it right soon. Like the parent who responds to a child's every complaint, the result is self-defeating. The child is spoiled; the economy becomes inflation-prone.
Second, recessions do not last forever. Consider the collaspe of auto sales. The industry simply does not have the cars people want. Economic policy cannot change that, but the companies' manufacturing plans will. In 1980, according to a report by a House subcommittee, the industry has a capacity for only 1.7 million newly designed, fuel-efficient cars. That is projected to rise to 3.3 million in 1981 and 10.1 million in 1984.
And third, crude "stimulus" programs will not solve deep-seated social problems. No one should minimize the impact of recessions on black Americans. Their economic status has improved significantly in the past 20 years -- dramatically in the 1960s, slowly in the 1970s -- but it still remains far behind that of whites. Even in good times, the black unemployment rate is about twice the white. Special job programs have yet to alter that, and real hope lies in the potential of the private economy.
What we need to understand -- and attack -- is the economy's ability to tolerate increasingly high levels of both inflation and unemployment. To say that prices do not respond to economic slump is a simplification. Automakers are heavily discounting now, and even steel firms discount in a recession. But once recovery starts, companies restore and raise list prices because their costs -- mainly labor costs -- have kept going up.
There are fancy explanations for this. Monopolistic companies and unions are blamed. Even in non-union firms, wage behavior is said to have changed. Companies roughly attempt to keep workers up with past inflation. There is much truth to these theories, but the habitual expansionary response of government to slowdown drives this inflationary behavior.
Based on experience, companies and workers regard slowdown as temporary. Fearful of being seen as an enemy of recovery, the Federal Reserve accommodates expansionary budget policies by increasing money supply growth. The increased money available for lending and spending provides the wherewithal to whip up wages and prices. Sooner or later, the Fed and the White House react in panic against the higher inflation, and the cycle starts anew.
Meanwhile, both inflation and unemployment rates have crept up. This still leaves a prosperous econony, but more and more people are excluded. And even those who share in the prosperity face the increased stresses of ever-higher inflation.
No change in government policy can promise instant stability, but it is possible to do better. The Fed has gone halfway toward a new approach by promising a slow reduction in the money supply growth. But the Fed will have a difficult time abiding by its pledge if government budgetary policy does not change.
A permanently balanced budget is a bad target. A recession naturally pushes the budget into deficit because tax receipts fall and welfare spending increases. These "automatic stabilizers" help cushion the decline. A better target, therefore, is the so-called high-employment budget, which is calculated as if the economy were operating at "high employment." That is now defined as a 5 percent unemployment rate.
The mistake of the past decade -- and particularly of the Carter years -- has been to run sizable deficits on this budget. The official estimates are probably understated because they do not count off-budget items and because the 5 percent unemployment rate is too low. These persisting deficits have tended to squeeze out private investment and put added pressure on the Fed to increase the money supply.
Because inflation pushes people into higher tax brackets, aiming toward this sort of budget balance would allow a modest offsetting tax reduction in 1981 -- if spending is not dramatically increased. That will not provide instant relief from economic distress. Past inflationary practices will subside only slowly, and economic expansion will be slow. But the alternative is a progressive worsening of inflation -- and, ultimately, unemployment.