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ECN202: Macroeconomics. 1980s: Reaganomics The Return of the Conservatives
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ECN202: Macroeconomics 1980s: Reaganomics The Return of the Conservatives "Reaganism was the rejection of traditional Republican policies of "austerity" - sometimes called castor-oil economics or deep-root-canal economics. But it was more than that. It was an assertion these policies could be rejected without also rejecting many conservative objectives or totems. "
1980s It was a bad decade – bad enough the voters turned to a peanut farmer and a B-rated former actor to lead the country in the presidential elections of 1976 and 1980. The culprit was stagflation and it marked the end of the line for liberal Keynesians and the reemergence of conservatives as the ideological pendulum swung back to the right where it had last been in the 1920s. The updated version of their policy was supply-side economics and Margaret Thatcher brought it the the UK and Ronald Reagan brought it to the US. There is considerable disagreement on the record of Thatcher & Reagan, but all can agree Reagan changed the trajectory of the US, just as Thatcher did in the UK. Under Reagan union membership began a death spiral with manufacturing jobs disappearing as globalization flattened the world, the deregulation of industry accelerated, he reversed the decline in military spending since the end of the Vietnam War, immigration increased with more of it coming from Mexico, and the gap between the rich and the rest was widened by his tax cuts. We’ll start with some headlines from the 80s.
In the news • “DESPITE the rise in the unemployment rate to 6.2 percent of the labor force in December from 5.8 percent in November, it is still not clear that the recession has arrived.” 1980 • “President Carter's comprehensive anti-inflation program, with its heavy stress on monetary and credit restraints, increases the likelihood of a steep recession later this year,” 1980 • “Dow Sinks 19.71 Points; Volume Up; Drop Attributed To Rising Rates, Recession Fears” 1980 • “Deep Recession Foretold At Economists' Meeting; Deep Recession Foretold” 1980
In the news • “House Passes Bank Bill Ending Some Ceilings on Interest Rates” 1980 • “High Interest Rates Blocking Sales” 1980 • “Mortgages: A New Ball Game?; Flexible-Rate Plan Alarms Consumers Mortgages: A New Ball Game?” 1980 • “17 % Mortgages Are Set on Coast” 1980 • “Almost one-third of the nation's 3,120 savings and loan institutions lost money last year” 1988 • “Deregulation Has Gone Too Far, Many Tell the New Administration” 1988 • “F.D.I.C. Takes Over 47 More Savings Units” 1989
In the news • “THE central dilemmas of economic policy today continue to be those that drove the Carter Administration out of office: Can we revitalize the economy, raise productivity, reduce unemployment, while at the same time reducing the stubbornly high inflation rate.” • “Spain's Daring Experiment In 'Supply-Side Socialism’” 1989 • “WAS the economic recovery of 1983-84 the result of the Reagan Administration's supply-side policies or of the Keynesian stimulus resulting from big budget deficits?”
The macroeconomic setting Ronald Reagan was unable to unseat a sitting president because of the sorry state of the economy that you can see in the following graphs. Take out that pad of paper and make notes on the situation facing the nation when it elected Reagan as president.
Confidence was down Confidence in US industry down = drags down stock prices
Fear was in the air Fear evident in the spike in gold’s price
Federal government was growing Outlays Receipts
Budgets were not balancing Those persistent deficits
Inflation rate was up Inflation up
Interest rates were up Pushing interest rates up
Wages down Inflation-adjusted wages falling
The malaise turns ugly Misery Index (inflation + unemployment rates) soaring
The “revolution” Thatcher in England Reagan in US
“We want a society where people are free to make choices, to make mistakes, to be generous and compassionate. This is what we mean by a moral society; not a society where the state is responsible for everything, and no one is responsible for the state.” “If you just set out to be liked, you would be prepared to compromise on anything at any time, and you would achieve nothing.” Thatcher: in her words
Thatcher: in other’s words “Thirty years ago [written 2009], over-regulation, over-taxation, mis-regulation, statism, state corporatism, and economic folly, cosiness and regulatory capture, and a crescent ideological enemy without, who were assisted by enemies – both fifth columnists and useful fools – within, had led to a crisis of confidence in the West, and in all lands that – and amongst all peoples, particularly those who were oppressed in their own lands, who – loved and desired liberty. Of course, thirty years ago, Britain had Margaret Thatcher to turn to.” “What I said was Britain was ready for another Hitler, which is quite a different thing to saying it needs another Hitler. I stand by that opinion - in fact I was ahead of my time in voicing it. There are in Britain right now parallels with the rise of the Nazi Party in pre-war Germany. A demoralised nation whose empire had disintegrated." Two years later, Margaret Thatcher was elected.
"This year, as in 1932, our country is divided, our people are out of work, and our national leaders do not lead. Roosevelt's opponent in that year was also an incumbent president, a decent and well-intentioned man who sincerely believed our government could and should not with bold action try to correct the economic ills of our nation.”Jimmy Carter stated in his Labor Day speech in 1976 The presidential campaign rhetoric
"I regret to say that we are in the worst economic mess since the Great Depression." Ronald Reagan New York Times Feb 6, 1981 "Can you look at the record of this administration and say, 'Well done'? Can anyone compare the state of the economy when the Carter administration took office with where you are today and say, 'Keep up the good work'? Can you look at our reduced standing in the world and say, 'Let's have four more years of this'?" Reagan The presidential campaign rhetoric
An Ideological Shift to the Right Whereas "'market failures' were the paramount economic concern of the 1960s and 1970s… 'government failure' became the preoccupation of the 1980s and 1990s. Of course, communism was the greatest 'government failure' of them all. And with that failure, the markets inexorably rose to take control of the 'high economic ground' on the world stage, and in the battle of ideas."
The Reagan Revolution: Promise • Defeat communism & reestablish US supremacy • Rebuild the military (Star Wars) • Increase value of stock market • Strengthen US $ • Reduce size and scope of government • Deregulate, cut spending, reduce transfer payments (welfare, unemployment), cut taxes & balance the budget • Tax cuts • Move emphasis from short-term to long-term • AS replaces AD as focus of policies • Worry less about stabilization and more about growth • Increase savings • Reduce inflation AND unemployment AND Increase SOL of US workers • Increase the openness of the US economy
Reaganomics according to Reagan "This plan is aimed at reducing the growth in government spending and taxing, reforming and eliminating regulations which are unnecessary and counterproductive, and encouraging a consistent monetary policy aimed at maintaining the value of the currency" Reaganomics according to others "a delicately balanced on a set of simultaneous policy actions and a set of equations describing the effects of the policy actions on the economy."
StagflationThe “scourge” of the 1970s Input prices up = AS shifts inward Inflation - up Output - down Unemployment - up Price level GDP
Alternative “solutions” to in AS: The Keynesian Dilemma “Fix” unemployment Th The inward shift in the AS drives the price level higher and GDP lower. Keynesians focus on AD, so in this situation where they want to fix unemployment they need to get GDP back to its old level. They would do this with an expansionary fiscal or monetary policy – the AD shifts right enough so the new equilibrium is at the same level of GDP Problem is: Now we have even more inflation Price level Price level Same GDP >inflation GDP GDP
Alternative “solutions” to in AS: The Keynesian Dilemma “Fix” inflation The inward shift in the AS drives the price level higher and GDP lower. Keynesians focus on AD, so in this situation where they want to fix unemployment they need to get GDP back to its old level. They would do this with an contractionary fiscal or monetary policy – the AD shifts left enough so the new equilibrium is at the same price level so no inflation. Problem is: Now we have even bigger recession and more unemployment Price level Price level GDP GDP
THE Reagan “Solution” Problem: stagflation due to adverse supply shock = higher inflation & lower GDP Solution: favorable supply shock Reverse stagflation So how do you do this? How do you shift the AS curve to the right? The answer is in the factors that affect AS that you looked at earlier
Reaganomics – expand the capital stock (incentives matter) K cost of capital Investment tax credit (see example) Accelerated depreciation (see example) pool of capital 401K plan Tax cut to wealthy corporate profit tax Fill in the following tables to see how Reagan would increase AS
Investment Tax Credit: Before 50% tax rate
Investment Tax Credit: Before 50% tax rate The investment tax credit reduces the cost of the machine = incentive to invest in machine
Accelerated Depreciation: Before for business ($1,000s) The accelerated depreciation reduces the cost of the machine = incentive to invest in machines
Reaganomics – expand the labor force (incentives matter) L return to working taxes return to not working welfare unemployment benefits Two examples of the use of incentives appear in the following two tables
Tax-bracket creep with inflation (10%) R = N/PI*100 With inflation the tax rate increases because of progressive tax = pushed into higher tax bracket without any increase in inflation-adjusted income
30% Across-the-Board Tax Cut Look at how a 30% across the board tax cut favors the high income earners when there is a progressive tax system. The “plan” was for this cut to give high income workers an incentive to work more because they keep more
Reaganomics: pursue conservative agenda government & retain government programs Promise to waste by cutting unspecified programs taxes 30% across board on personal income taxes balance budget Laffer curve
Laffer Curve @ A what do you do to raise tax revenue? Raise tax rate @ B what do you do to raise tax revenue? Lower tax rate Answer depends and Reagan said we were in B range Tax revenue A* B* B A Tax rate
The Reagan Years The good news
The Reagan Years The not so good news
Cities emptiedFactories closed The numbers are spectacular – in the nation’s biggest cities white-flight continued as non Hispanic Whites left the central cities for the suburbs. In the decade NYC lost .5 million, while Chicago lost .25 million. And with those people went jobs. In the country’s 10 largest cities manufacturing employment fell over 60%, with NYC losing almocy .5 million jobs – more than a 75% loss.
Bill Testa, “Manufacturing exit tough on Midwest central cities,” Chicago Fed
