I became almost apoplectic about our dilemma and pressed Schultze for anti-inflation alternatives. In a conversation on October 19, he said that we could further restrict federal spending, impose Nixon-style wage and price controls, or use the presidential jawbone.62 But he told me his Brookings Institution friend Arthur Okun had come up with a genuinely original idea: a tax rebate to companies and unions for any collective-bargaining agreement that came in at or below our inflation guidelines; he gave it the catchy name Real Wage Insurance. Its only problem—once again—was political: it would prove difficult if not impossible for Congress to write the idea into law. Blumenthal believed it would get in the way of tax reform. Business leaders regarded it as too close to price controls, and labor saw it as suppressing wage demands—which is precisely what it was intended to do.
This dismal conversation led me to understand later one of the reasons Jimmy Carter would lose the 1980 election. I had the feeling that the administration had lost the capacity to deal with the economy’s worst problems through any conventional means short of inducing a recession or imposing Nixon-style wage and price controls. This proved accurate, and I was not alone. The next day, at a breakfast meeting of the EPG, Blumenthal said it was time for the president to give a major speech on the economy. Schultze agreed but argued it needed to be a coordinated message on taxes, inflation, and jobs. But we had no policy to coordinate, and Schultze continued to insist that without another stimulus, growth would slow and unemployment would start rising. His prescription: a $20 billion tax cut. Back to square one.63
* * *
One by one Carter’s campaign promises on the economy and taxes began drifting out of reach. In late October the Budget Office told him there had been a negative $50 billion swing in the budget assumptions since the spring review. He could no longer put off the choice that Schultze presented him between his goal of a balanced budget and a tax cut that would stimulate growth, but leave a budget deficit of $20 billion. The president paused for what seemed like an eternity and then said: “It is devastating to me to give up a balanced budget.” Schultze tried to console him by saying we would try to do nothing that would make a balanced budget impossible under high-employment conditions—our preferred strategy.64
As we approached the mid-January deadline for Carter’s 1978 State of the Union and budget message, we recognized that our anti-inflation tools were not working or would be denied to us by Congress, setting off a frenzied quest for alternatives that simply did not exist. Departments were asked to develop their own anti-inflation policies to set an example to the private sector, but it was an exercise in futility. Blumenthal and Schultze presented modest initiatives like reducing telephone, excise, and sales taxes, and voluntary wage and price guideposts similar to those used by Kennedy and Johnson, in a much lower-inflation environment, and even then to little effect. And Carter himself never gave up on his goal of a balanced budget, which left Blumenthal “surprised at the president’s elementary notions of economics”—a condescending remark unlikely to win friends in the administration. It became obvious that the positive economic effect of the stimulus package of tax cuts and tax reform we were developing depended on lower interest rates. This proved a serious mistake and only fanned the flames of inflation.65
Carter was fighting a two-front war, facing ideological hurdles within his own party and constituency groups for whom fighting inflation was not a natural proclivity. He tried to put it in terms they might accept at a March 21 congressional breakfast, telling the Democratic leaders he was “most concerned with inflation, but we are ahead of schedule in reducing unemployment.” A month later he told the same skeptical group: “I think it helps Democrats to have me out front on fighting inflation, and it will help with the criticism that we Democrats are free spenders.” Budget-busting bills, he said, create “an image of irresponsibility.”
This was too much for Tip O’Neill, who accused Carter of following the “Republican line that government spending creates inflation. Mr. President, we have been working on a different philosophy since the 1960s.” He added that Democratic economists had estimated that a $25 billion deficit would increase inflation by only 0.2 percent. Carter shot back: “Mr. Speaker, we already have a $60 billion deficit.”66 Carter got a more sympathetic ear from the House Budget Committee chairman, Robert Giamo of Connecticut, who agreed that while budget deficits were only one contributor to inflation, and not the most important, they were “the only thing we can control—but most Democrats do not believe this.”67
BURNS OUT, MILLER IN
The classic way to fight inflation is through higher interest rates. Former Federal Reserve chairman William McChesney Martin famously said that the job of the central bank was to take away the punch bowl once the party got going. It should be the ultimate watchdog against inflation—but the fact was that given the state of the economy, there was hardly any party at all. Nevertheless, in the spring of Carter’s first term, Burns had begun to raise interest rates. In August, Burns asked to have lunch with me, and this time I went to the imposing marble Federal Reserve Building on Constitution Avenue.68 He argued for a tougher line on inflation, but he was also clearly angling for the president to reappoint him. During Carter’s first year in office, everyone pressed Burns to run a looser monetary policy to facilitate growth. And as the economy picked up, the central concern was a potential pause in growth later in the year, reflecting a clear Democratic bias toward promoting growth over controlling inflation, until it was too late.
When Schultze and I later met with Burns to solicit his ideas on our inflation package to start Carter’s second year in office, he suggested that the president and his top appointees set an example by taking a pay cut of 5 or 10 percent and asking the private sector to join in, led by its top executives. That was our last meeting with Burns as chairman.69 At an early December meeting of the EPG, Carter declared he would not reappoint Burns when his term ended on December 31 and asked for candidates to replace him. He turned away from the economics profession toward business, and the president decided on G. William Miller, chairman of Textron and head of the National Association of Businesses, where he had encouraged large corporations to hire the needy. A Democrat with a heart and concern for the disadvantaged, Miller was short and pleasant, spoke in a clipped, clear, and direct manner, but proved out of his depth in dealing with the arcana of monetary policy (although he proved to be a more effective treasury secretary).70
“GOVERNMENT CANNOT SOLVE OUR PROBLEMS”
The president delivered his first formal State of the Union Address to a joint session of Congress on January 19, 1978, almost a year to the day after his inauguration. All the late hours, all the pressures of working in the White House, can be forgotten in an instant whenever the president you serve speaks in the vast and beautiful chamber of the House of Representatives. As everyone rises, the clerk of the House announces in solemn tones: “Ladies and gentlemen, the president of the United States.” Members come early to get seats on the aisle to be seen on TV shaking the president’s hand as he strides into the well of the House.
It is our republic’s democratic borrowing of the British tradition of the monarch’s annual speech to Parliament presenting the government’s program. As such, the president presents his domestic- and foreign-policy priorities before all members of the House and Senate, the cabinet, the Joint Chiefs of Staff, and the Supreme Court, plus ambassadors from every nation with whom we have diplomatic relations. The mandate is written into the Constitution for the president “from time to time to time give to the Congress information on the State of the Union, and recommend to their Consideration such measures as he shall judge necessary and expedient.”
Every president has fulfilled it. The shortest message, of only 1,089 words, was the first, delivered by George Washington in writing.71 Carter’s would be much longer, since the State of the Union also serves a unique purpose. Amid all the hurly-burly of American politics, with all the American people’s natur
al focus on their own jobs, families, welfare, and security, this one speech offers the president his sole guaranteed opportunity to speak to them directly about his hopes and dreams, his vision for the country, and how to meet its challenges and opportunities.
Carter’s address focused almost exclusively on the need for a further stimulus to the economy by cutting taxes and expanding programs to create jobs. He announced a total tax reduction of $34 billion, offset by $9 billion in tax reforms, most for individuals, for a net cost of $25 billion. There were no details on tax reform, which would be presented the next day in a detailed presidential message. But he emphasized that cuts in personal and corporate taxes must be tied to tax reform because the loophole-closing revenues from reform would provide the fiscal room for lower taxes. On the economy Carter largely brought good news. The president offered barely a glimpse of our anguished internal debates about the simultaneous challenges of high unemployment and high inflation, and precious few tools to fight inflation. From that perspective it was a lost opportunity to educate and prepare the American people for the difficult choices posed by stagflation.
But he was no different from other presidents in accentuating the positive. In detailing previously the challenges we faced in reforming the structure of the nation’s energy supply, Carter had been frank. Not here, however. The president asserted: “We reached all of our major economic goals for 1977”—with four million new jobs, inflation down, and wages up. He conceded that inflation was “still too high, and too many Americans still do not have a job.” And he offered only a glimmer of our problems of governance by admitting he had no “simple answers.” His economic policy, he said, was based on four principles: expanding the economy to produce new jobs and better income; the expansion must be led by private business and not the government; inflation must be brought down because it slows economic growth and hurts the poor; and the United States must contribute to the strength of the world economy.
In outlook the speech was the most conservative economic declaration from a Democratic president in modern times: “There is a limit to the role and the function of government. Government cannot solve our problems. It can’t set our goals. It cannot define our vision. Government cannot eliminate poverty or provide a bountiful economy or reduce inflation or save our cities or cure illiteracy or provide energy. And government cannot mandate goodness. Only a true partnership between the government and the people can ever hope to reach these goals.”72
So he rejected mandatory wage and price controls in favor of a voluntary program in which government, business, and labor would work together to hold the year’s wage and price increases below the level of the previous two years. Given the opposition of labor and business to numerical guidelines, I was pleased we could be at least this specific in trying to ratchet down inflation. After all of our work, this was a balanced program for a New Democrat. If we could have frozen in time the economic situation of the country at this shining moment, the country and the president would have been in good shape. But worse lay around a corner that not even the best of our economists could see.
* * *
During the spring came new initiatives to slow the wage-price spiral. Carter set a national inflation goal of 5.5 percent, and in an April 1978 speech to the American Society of Newspaper Editors, he set an example for the private sector by placing a 5.5 percent ceiling on federal pay, and freezing the pay of the White House staff and his other executive appointees. He named Robert Strauss special counselor on inflation, whom the press dubbed “Inflation Czar.” With characteristic lack of coordination, the president did not bother to inform Blumenthal in advance, and the Treasury secretary bitterly complained to Mondale and me that the appointment would diminish his role as the administration’s principal spokesman on the economy and inflation, and further fragment economic decision making. He did not even want Strauss mentioned in the president’s anti-inflation speech.73
If any human being could talk labor and management into moderating their behavior, it certainly would be Strauss, Washington wheeler-dealer par excellence as former chairman of the Democratic National Committee and successful negotiator of the languishing Tokyo Round of international trade talks. He could be at once charming and tough, informal and theatrical, with four-letter words spewing out naturally. But Strauss was given no authority, no leverage, no staff. He did succeed in at least delaying some raises in the steel and auto industries, “but it was like charging hell with a bucket of water. You couldn’t put out the fire,” he told me.74 By the end of August he had succeeded in persuading more than one hundred companies to take “positive steps” to decelerate inflation. But Strauss felt the administration lacked muscle, such as the threat of formal controls, because “you’ve got to have something to hit them with.” The biblical jawbone was simply not enough, and Strauss complained that the Carter program had only a carrot but no stick, let alone a jawbone.
Even though the president himself walked over from the White House to sit in on several Strauss-led meetings with management and labor in the Old Executive Office Building, and emphasized the importance he attached to fighting inflation, he was not terribly convincing. When Carter, Strauss, and I met with Meany and the AFL-CIO brass on May 10,75 the president gave away his own leverage when he said: “I do not think wages are the cause of inflation, nor do I intend to stop it by creating unemployment, or by wage and price controls. Nor do I expect you to take the first step.” He said business was better able to take the initial steps on prices and asked the unions for a pledge to decelerate wages. But then he let them off the hook by saying it would be “okay to make it contingent on price restraint.” He did show some muscle by warning that if they did not cooperate, a Democratic Congress would be less likely to support his proposals for a higher minimum wage and tougher labor laws that would make it easier to organize workers.
Strauss then assured them that the business leaders would fall into line. Meany expressed his support for the president’s efforts to fight inflation but claimed that his hands were tied: “I can’t pledge to do what I can’t deliver.” His excuse was that as the umbrella organization for numerous international unions, the AFL-CIO could not control negotiations with their employers. In Strauss’s more blunt recollection, “Meany told the president and us in a nice way to go to hell.”76 The proof of the pudding was soon cooked into the outcome of the year’s labor settlements. All the major union contracts during 1978 exceeded the president’s targets.
A 110-day miners’ strike ended when the coal companies caved in to pressure from Energy Secretary Schlesinger. With Ham Jordan and the White House political staff supporting him, Schlesinger argued that millions of people would be thrown out of work as coal shortages slowed the economy. Schultze countered in vain for the president to hold fast against the miners, but in the end he ruefully agreed that it was the administration as a whole that “caved in.”77 The workers won wage and benefit increases of more than 20 percent for the first year and 36 percent over the three-year contract period. This was a lost opportunity for the president to stand up to outsize union wage demands, as Ronald Reagan would do early in his presidency in breaking the air traffic controllers’ strike—although it was much easier to find replacements for the controllers than the coal miners. I certainly did not urge him to take them on. Then, emboldened by the miners’ success, electrical workers in San Francisco won a settlement in May worth 30 percent over three years. And just as we were working to deregulate railroads, 120,000 rail workers won a 35 percent wage increase over three years.
With each passing month, the inflation numbers grew worse, but Congress seemed unconcerned. Carter was peeved when Speaker O’Neill brought to the House floor a spending bill for the Health, Education, and Welfare Department that passed while the administration was negotiating a lower number. The president accurately said: “I am being pushed around as the Democratic leadership joins together.” Schultze presented dismal inflation forecasts, to which Carter responded: “I a
m really holding tight on the budget. I was reluctant to veto bills last year, but not now!” For the first time Schultze worried that the Fed would demand drastic action in cutting the budget to avoid further rate hikes. Carter at first shrugged this off but not for long. As he opened the spring budget review on May 16, he complained about the economic forecasts: “Each time we overestimate the need for a stimulus; this is a consistent mistake. We have a real interest in keeping interest rates down and not letting the Fed think they’re the only anti-inflation act in town.”78
Official appeals and mild government pressure had clearly failed. This pointed up a fundamental mistake our team, myself included, made by opposing higher interest rates until it was too late. They could have done more to tame inflation than anything we could have done to cut the budget, but we resisted for fear that either or both would slow growth and tip the economy into recession. We continued to be torn between fears about inflation and unemployment—the stagflation dilemma. At an EPG meeting Schultze neatly summarized our unpalatable options: “Ride it out, or wring it out.”79
Schultze’s explanation to the cabinet in July was about as close as we came to a theoretical understanding of what was happening in the real economy. In the previous months the unemployment rate dropped 2 percentage points and 6.5 million more people had jobs—but the economy had not grown at a rate sufficient to produce that many jobs. This meant that more people were in effect producing less, and that helped feed inflation. Why the lower efficiency? Productivity was falling, and Schultze admitted that not only did he not know why or what to do about it, but neither did his colleagues in the economics profession.
The precipitous drop in the productivity of the American economy showed up only gradually in the statistics, and it was Carter’s bad luck that it was becoming evident on his watch.80 Productivity did not start reviving for another generation through the digital revolution, and by the end of the twentieth century, many of the protections that had been erected to mitigate the inevitable inequities of competitive capitalism had been dismantled or were in disrepair—labor unions, financial regulation, antitrust law, and progressive taxation. When the strong tide of innate American innovation finally did arrive, it no longer lifted all boats, to update President Kennedy’s famous metaphor. And mysteriously, by the last part of the Obama administration, productivity again became sluggish.
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