The anti-inflation policy that Ronald Reagan's key advisers are proposing for next year involves an unprecedented exercise in positive thinking.
Initially, the Reagan program appears likely to make things worse.
There will be no direct attempt to control the most visible signs of price inflation -- the rising costs of food, fuel, housing and consumer credit.
And Reagan's promise of a $40 billion annual tax cut in 1981 looks like it would be add to inflationary pressures, not reduce them, since it may prove impossible for Reagan to produce an equal amount of spending reductions next year, and the federal deficit is thus likely to grow. The current, 981 fiscal year, which ends next Sept. 30, will be half over by the time Reagan takes office, notes Rep. Jack Kemp (R-N.Y.), one of his advisers.
But Reagan advisers like former Treasury secretary George P. Shultz say that Reagan program can have a powerful "electric effect" next year on inflationary expectations, reversing the widespread belief among consumers, investors and business executives that contnued double-digit inflation is inevitable.
Budget cuts are one side of Reagan's "supply-side" economics, reducing the federal government's role in the economy. The other side is a program of tax cuts intended to reward savings and investments, providing the capital to create new jobs and finance economic growth. The hoped-for result in the long run: a bigger economy with government taking up a smaller share than now, a much-enhanced capacity to produce goods and services, and therefore less inflationary pressure on prices.
And even though significant cuts would not begin to take effect until a year from now and in the federal budgets that follow, an impressive start on budget-cutting would send out a strong signal that a Reagan administration was committed to opposing inflation, the Reagan camp believes.
The message would be picked up first, his advisers say, on Wall Street and the other financial markets where the Treasury Department and private corporations sell bonds to help finance the operations of the government and the private sector.
Because the investors in these markets now expect high-level inflation to continue indefinitely, they protect themselves by demanding high interest rates on long-term private and public bonds. The rates have risen so high that most companies simply are refusing to borrow in this way.
That forces the companies to borrow in the short-term credit markets, putting them in competition with consumers who want to finance autos and other purchases.
If these investors are convinced that control of federal spending has begun, their confidence in the future will turn upward, and they will settle for lower interest rates on long-term bonds, Reagan aides say. Companies will return to the bond markets, relieving pressure on consumer credit.
These shifts, coupled with the tax changes Reagan proposes to reward investment and savings by companies and individuals, will start the economy on an upward path of steady growth, they say. This is the "prosperity for all" that Reagan has promised and it will end the inflationary spiral, they promise.
Unless there is some fundamental change in inflationary expectations, long-term interest rates may stay so high that no recovery will be possible, says Alan Greenspan, a Reagan adviser and chirman of the Council of Economic Advisers in the Ford administration.
"In a sense, we cannot have full recovery until mortgage interest rates, and long-term interest rates generally, come down substantially," he said in a recent forecast.
This is their hope. But ahead lies a new surge of inflation that will rattle the Reagan administration. Economists are predicting an increase of some 13 percent in food prices next year; gasoline and other petroleum prices could increase by 15 percent or more in the aftermath of the Iran-Iraq war, and pay is expected to rise by about 10 percent.
The Reagan economic strategy has no immediate answer to these price pressures, concedes Kemp. Reagan has vowed to remove the remaining price controls on U.S. energy sources to stimulate more production, but the payoffs will be years away. Meantime, decontrol will increase energy prices here.
There will be no attempt by the Reagan administration to pressure companies and workers into limiting themselves to "acceptable" price and pay increases spelled out by the government, advisers predict. That approach is "as extinct as the dodo bird," says Reagan adviser Paul McCracken, former CEA chairman under President Nixon.
The outlook for next year, then, is for continuing high-level inflation and a slow recovery. The Federal Reserve Board is convincing even its critics that it means to slow the growth of the money supply to fight inflation. Reagan and his economic advisers, of course, have been crying "Right on!"
Millions of workers will remain out of work during the next two years, and this slack in the economy will be the underlying anti-inflation program of the coming administration.
Kemp and other Reagan supporters have great confidence in Reagan's ability to sell his program to the public. That ability will be tested when Reagan deals with the federal budget deficit.
Reagan advisers have singled out the rapid growth in federal spending this summer as a severe inflationary problem because it increases the budget deficit -- the difference between what the government spends and what it collects in revenues -- and thus leads the government to borrow more heavily. The criticism does not extend to the defense budget, which the new administration is pledged to increase.
And the Reagan advisers suddenly stop complaining about the budget deficit when they discuss their plans for a 10 percent cut on individual tax rates in each of the next three years, plus substantial cuts in business taxes.
These tax cuts will make the deficit worse by reducing revenues, at least over the next several years. If Reagan is right, and his tax cuts speed up investment and productive economic growth, the benefits will still show up only gradually.
Reagan isn't the first incoming president to promise to cut taxes while bringing the budget into balance by encouraging the growth of the economy. That, too, was Jimmy Carter's promise.
Reagan says he'll do it differently and succeed where Carter failed, but he won't even have a full four-year term to do it, Kemp and other advisers concede. If positive results aren't apparent by the 1982 congressional elections, the opportunity Reagan and the Republicans won this month probably will have been lost, they say.