Economic Report of the President

een due to overall demand in the economy pressing on availablesupply. Throughout the past decade, the slowing growth in productivityhas pushed up the increase in business costs, adding its bit to therise of inflation.Late in each of the three inflationary episodes monetary and fiscalrestraints were applied, and at the end of each a recession took place,with rising unemployment and idle capacity. Inflation did fall backsomewhat, but at the end of each recession it had not declined to thelevel from which it started. And so the inflationary process has beencharacterized by ratchet-like behavior. A set of inflationary causesraises the rate of inflation; when the initiating factors disappear, inflationdoes not recede to its starting position despite the occurrenceof recession; the wage-price spiral then tends to perpetuate itself at anew and higher level. Instead of an occasional 3 percentage pointrise in inflation, which disappeared when the initial causes of the inflationwere gone, our basic inflation rate rose first from 1 to 4 percent,then from 4 to 7 percent, and in this latest episode from 7 to10 percent. It is this downward insensitivity of inflation in the face ofeconomic slack that has given the last 15 years their inflationary bias.A number of facts that are important for economic policy can bedrawn from this history. First, excessive demand in the economy, fedby an overly large Federal budget deficit or excess growth in themoney supply, was the major factor in one of the three inflationaryepisodes and played a subsidiary role in the other two. Second, twicein the last decade the tendency for government to stimulate theeconomy somewhat too freely during the recovery from recessionprobably played a role in retarding the decline of inflation or renewingits acceleration. That is why I was so insistent that a tax cut designedfor quick economic stimulus not be enacted last year. Third,because the rate of increase in wages and prices did not decline veryreadily in response to the discipline of budgetary and monetary restraint,that restraint resulted only partly in reduced inflation; it alsotended to retard the growth of output and employment. Finally, massiveincreases in world oil prices have twice in the past 7 years helpedtrigger a major inflationary episode. While we cannot eliminate Ourvulnerability to such shocks, a reduction in that vulnerability will improveour chances of avoiding new inflation in the future.These realities dictate the broad tasks that economic policy mustaccomplish over the years ahead:Our monetary and fiscal policies must apply steady anti-inflationary restraintto the economy. The restraint must be strong and persistent enough toconvince those who set wages and prices that the government meansto stand by its guns in the anti-inflation fight. But it must not be sosevere or so restrictive as to prohibit even moderate economic