For the Next President, a Bout With Inflation : Accepting a Little to Sustain Growth Is a Problem We Might Have to Live With

A specter is haunting American politics; it is the specter of inflation.

Yet neither side in the presidential campaign wants to raise this unpleasant issue. Not George Bush, for that would give the lie to the greatest supposed accomplishment of Reaganomics. And not Michael S. Dukakis, for even talk of inflation is not thought good for Democrats. And, in any event, neither candidate is ready to say what, if elected, he would do about inflation.

Standing small in this breach is Federal Reserve Chairman Alan Greenspan, who after long delay now admits that inflation is again a problem. To this he offers a most unserious solution. Small, irregular increases in interest rates are the order of monetary policy this year. These increases are enough to signal anxiety but not so large, we are assured, to threaten the economic expansion. But tight money and high interest rates work against inflation only by slowing economic growth. Measures too weak to slow growth will not appreciably slow inflation.

The fact is that the roots of this inflation are deep, going back to the Reagan Administration’s decision to depreciate the dollar and restore the growth of exports in 1985. It was a necessary decision at the time; otherwise the expansion itself would have ended. But it had a large, inevitable, unacknowledged consequence: No amount of tight money and high interest rates, short of recession, can stop inflation now.

If Bush becomes President, precedent suggests that he will deal with inflation as Ronald Reagan did: an early, sharp move to supertight money, taking a recession and high unemployment in 1989 or 1990 so as to restore non-inflationary growth by 1992. If so, the ‘90s will replay the ‘80s with even larger Keynesian deficits necessary to revive the economy once the bout with old-time religion is over.

For Dukakis the problem is much more difficult. His commitment is to those (the poor and the middle class) who are not cushioned against the effects of recession. His program requires steady growth of the federal revenue base, and so is predicated on sustained economic growth. Dukakis cannot produce social progress and cope with double-digit unemployment at the same time.

Should Dukakis be elected, is there a way for him to get out of this dilemma? I believe so, provided that he and Greenspan agree to work together, on the basis of three jointly accepted principles:

--If recession is bad policy, then the urge to slow inflation with high interest rates must be resisted. The Administration and the Federal Reserve should agree instead on the priority of sustained growth, without recession, even as both work to cut the trade gap and restore fiscal order. This means that, as Dukakis reduces the deficit, the Federal Reserve should cut interest rates sharply and let the dollar find its floor in the market. This would spur the continued growth of investment and exports on which growth depends. Meanwhile, deficit reduction would help transfer resources from consumption to the export and investment sectors.

--It is time to settle and not merely manage the debt crisis of the Third World. Settlement must come on terms that favor development, not sterile interest payments on old and unproductive debt. Such a settlement would further raise demand for advanced U.S. investment goods, our major export. And, as a settlement is reached, the Federal Reserve must act to preserve the stability of the U.S. banking system, including bold action to quickly recognize a few irretrievable institutions.

--The United States must pursue a concerted strategy to raise growth rates among our advanced trading partners. Japan and Britain can be encouraged to continue what they have already started. West Germany, a more difficult case on whose policies the fate of Europe depends, must be subjected to unremitting political pressure, and especially to the discipline of a competitive dollar.

Taken together, such policies can work to sustain American and world growth through the first term of the next Administration. Yet under this strategy a higher inflation rate is certain, for a time. It is a sad fact that we cannot correct the trade deficit or control the runaway pileup of external debt without some temporary cut in average national living standards. The cost of securing sustainable growth is, in effect, a period in which prices rise more rapidly than wages. But this period can be short. And the sacrifice need not entail the pointless loss of investment, employment and growth due to recession.

With creative policy, a President Dukakis could work to complete our adjustment to the new world structure of costs and prices quickly, and so restore price stability without recession. The trick is not to prevent the rise of import prices and the expansion of exports but to restrain wages after the import price shock has been felt and so to prevent hard-won competitive gains from getting lost in a new wage-price spiral.

For this, however, Greenspan, a Reagan appointee with a fixed term, must accept his assignments: growth, development and financial stability. He must leave the management of inflation, the task of keeping the necessary adjustment within tolerable bounds, to the President. And the President must prepare himself to broach another topic that is even more forbidden, in recent discourse, than inflation itself: an incomes policy.