Economic Report of the President

makers face are not symmetrical and, as a consequence, uncertaintymust be resolved in favor of caution.Third, no matter how well designed, monetary and fiscal policiescannot prevent large outside shocks to the economy from imposingsome damage on employment, price stability, or growth. A practicalapproach would be to "accommodate" the direct inflationary effectof external price shocks but restrain aggregate demand sufficiently tominimize the indirect inflationary effects that would result if individualsattempted to raise wages and other incomes to "catch up" withhigher prices. Without huge costs in terms of lost production, however,it would probably be impossible to restrain demand sufficiently toeliminate all induced increases in inflation. In these circumstances avoluntary incomes policy may be able to make a significant contribution.This seems to have occurred in 1979, when the response ofwages to the large rise in inflation was substantially muted.Because the rate of increase in wages and prices tends to resistdownward pressures, a policy of continued restraint on the growth ofaggregate demand sufficient to induce a decline in inflation will meansustained slack in the economy and will result in a period of relativelyslow growth in production and employment. This outlook could beimproved if it were possible to change the behavior of wages andprices so that they responded to demand restraint more rapidly andby larger amounts.THE ROLE OF EXPECTATIONS AND THE CREDIBILITY OF DEMANDRESTRAINTEarlier in this chapter the downward resistance of wage and priceinflation was attributed in part to a widespread expectation that expansionarygovernment policies will rather quickly be applied to reverserecessionary tendencies. If firms and workers became convincedthat the government meant business, that the markets fortheir products would not be supported by easier money or fiscalstimulus, and that they could continue raising wages and prices onlyat their own peril, their decisions about wage demands and pricingpolicies would undoubtedly be affected. The downward "stickiness"of wage and price inflation would be eased.Does the government need to put the economy through one ormore prolonged periods of economic slack in order to demonstratethe firmness of its anti-inflation commitment? Or can it avoid thatnecessity by somehow convincing the Nation in advance of its determination?Some observers have suggested, for example, that the governmentcould show its resolve by announcing a target path fornominal GNP or for money supply growth (or both) and by committingitself to pursuing those targets whatever the consequences forunemployment and production. The target path would permit pro-48