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The Economics of Recession

The administration's theory emphasized the impact of oil shocks on "core inflation." In mid-1979, the Organization of Petroleum Exporting Countries (OPEC) doubled oil prices. Oil was more expensive, so the nation would have either less oil or less of something else. In real terms (product


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per person), paying more for oil meant less personal income. As prices affected by oil rose, workers would try for proportionate pay increases in their wage bargaining. If workers succeeded, businesses that gave raises would immediately raise prices, hoping thereby to recapture profits. Then workers in other industries would react to these new prices by demanding higher wages from their employers. Wages and prices would chase each other at increasing speed, both spiraling upward, as employer and employee groups strove to stick the other with the cost of OPEC's oil. At worst, the spiral takes on its own life, as workers and managers expect it to continue, separate from its original cause.

This self-perpetuating spiral is called the core inflation rate. Administration economists believed that core inflation was up to 8 percent in 1979, and heading much higher, and their solution was to keep wages from chasing prices; the only reliable way to do this was through unemployment, which would pressure workers to accept smaller wage increases or lose their jobs to those already unemployed. Thus, as John Berry of the Washington Post reported the policy, "slower economic growth and higher unemployment [were] the key to both the short-run and the long-run attack on rising prices."[12] Chairman of the Council of Economic Advisers Charles Schultze said that "the Administration's greatest fear involves a further increase in inflation if workers try to recover some of the purchasing power lost last year to inflation and, particularly, to higher oil prices."[13]

While Carter's dilemma recalled Goldilocks, reactions to the budget reminded us of the classic Japanese story of Rashomon, in which the same event is reported entirely differently by various participants and witnesses. The National Journal titled its story, "A Campaign Budget for an Election Year," mentioning all the bows to defense, domestic programs, and anti-inflation pressures while somehow ignoring the electoral problems presented by tax increases. But The Economist proclaimed:

The deficit is an infinitesimal part of a $3 trillion GNP and is dwarfed by the foreign tax imposed on the American economy by OPEC's increased oil prices. President Carter has presented a non-electioneering budget in an election year. Such courage deserves to succeed.[14]

Time described the galloping inflation and concluded that "the injection into the economy of new cold war defense spending, without any concomitant reduction in social expenditures, could be like hitting the gas pedal in a car already careening out of control down a hill."[15] Newsweek's writers saw the exact opposite. "At bottom," they concluded, "the Carter budget obviously reflects the lessons learned in the late 1960s when Lyndon Johnson's pursuit of a guns-and-butter policy started the nation on a road to a disastrous inflation."[16]


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These different judgments reflected the clashing perspectives about the economy that observers applied to Carter's set of choices. Each columnist wrote as if the analysis was self-evident but each analysis, of course, was not. The agreements and disagreements among competing schools of economists would, however, influence budget politics until the present time. We pause to describe the competing schools.


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Two Democrats in a Budget Trap
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