Still interested? Well buckle up and enjoy the ride. However, I must warn you that this trip might be a little wonkish…
When G. William Miller was appointed Fed Chairman in 1979, the economy was suffering from OPEC coordinated oil price shocks throughout the 1970's. These sustained high prices began reducing aggregate production possibilities because of all the markets directly and indirectly influenced by crude oil (e.g. plastics, transportation, shipping, heating, etc). Moreover, the increasing price of crude oil also began compounding inflation (i.e. typical inflation + oil price inflation) and raising the expected rate of inflation.
However, Miller believed that this reduction in production was an indicator that there was a negative shock to aggregate demand. In other words, he believed the economy was going to into a recession. Therefore, he lowered the real interest rate and increased the supply of money to bring production back to what he thought was potential output. This is what the Fed would typically do in a recession.
The truth is, there was no aggregate demand shock and lowering the real interest rate boosted production beyond potential output. As a result, firms raised their prices beyond the original rate of inflation to ease the pressure and to keep up with “expected” inflation.
Moreover, up until this point, conventional wisdom (and Miller’s main strategy) stated that there was a permanent trade-off between unemployment and inflation. The short-run models based on the Phillips Curve during this time period were incorrect. The models reflected the belief that output could be permanently held above potential and unemployment could be held permanently low by pegging the inflation rate around 5%. However, this was proving to be counter intuitive because firms began “expecting” the increases and adjusted accordingly.
While we know now that there IS a trade-off between unemployment and inflation, it is not permanent. Milton Friedman and Edmund Phelps adjusted the Phillips Curve to reflect changes in inflation and to show that keeping output above potential is inherently doomed to fail.
In 1979, after Miller’s short term as Fed Chairman, Volcker aggressively used Friedman and Phelps’ newly adjusted model and “forced” the country to go into a recession and ultimately bring down inflation. To do this, Volcker raised the real interest rate which created unemployment. Once inflation was brought down to a manageable level, the real interest rate was lowered and employment began to rise. The economy was once again soaring. In effect, modern monetary policy was born.
This lesson in inflation not only caused a major downswing during the Carter administration, but it also created a major upswing during the Reagan Administration.
Contrary to popular belief, Reaganonomics or Trickle-Down economics was not responsible for the upswing in the economy. Let's take a closer look.
This graph shows the timeline of when Reagan’s infamous Economic Recovery Tax Act was enacted and when Volcker expanded the money supply after inflation was brought under control.
During 1981, Reagan slashed taxes under the premise that bourgeois entrepreneurs would then take their money and invest it in production. In effect, the rich would then shower us with their extra money in the form of jobs and higher wages.
However, there was actually a sharp decline in the rate of personal investment in 1981 and again in 1982. At the end of 1982, Volcker expanded the money supply. Shortly afterwards, there was a sharp increase in the rate of personal investment and job growth. Who was responsible Reagan or monetary policy?
Some make the argument that this occurrence was actually a lag effect from Reagan’s tax cut. That’s fine. But then could somebody please explain to me why there was an aggregate decline in the rate of investment during the entire Reagan Administration?
Source: http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=GPDI&s[1][transformation]=pch (percent changes of GDPI annual sum)
*The aggregate data was downloaded and analyzed in Microsoft Excel.
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Update
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My GDPI trend-line does not show a decline in gross investment. This is a graph of percent changes and illustrates something much different. I used percent changes to show how investment has moved over time. While gross investment was still increasing, it was doing so at a decreasing rate. In other words, private investment rates were higher in the 1970's before Reagan's tax cuts.
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For those of you who I haven't lost by now, I leave a final illustration of my point. The following graph shows another timeline of the Economic Recovery Tax Act of 1981 and when Volcker expanded the money supply. Except this time it is in relation to GDP growth and the unemployment rate.
The graph clearly illustrates an immediate reduction in unemployment with a concurrent increase in GDP growth after Volcker loosened monetary policy by dropping the real interest rate and increasing the supply of money.
In the end, it is fairly obvious to see that Volcker manufactured the upswing in the economy that defined Reagan’s presidency. On a theoretical plane, I can see how people could believe that tax cuts for the rich will create jobs. However, Reaganomics simply doesn’t pass the test of empirical observation.
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Update
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I would also like to quickly mention another concept correlated to investment: savings.
Clearly, the rate of savings and investment went down under Reagan. Where exactly did all the money go that was supposedly "freed up" from the tax cuts for investment? I just report, you decide!
10 comments:
Write a CLEAR Hypothesis at the beginning; either in "If-Then" format or as a declarative statement. If your objective is to show how important 'Monetary Policy' is, then the article is excellent, but you'll be preaching to the choir.
Look for another point in history when nearly all economic factors are the same, but only monetary policy is different. This will help with the scientific analysis.
Avoid contradictory statements like; "I will challenge some of your assumptions" this statement is an 'assumption' itself...
There are multiple factors that come into account when analyzing the economy as a whole.
Your Graph on 'GPDI' does not have a reference or citation.
Also investment measured with S&P 500 as well as the Dow Jones goes UP during Reagan's administration as well.
If you want to analyze the relationship between, Volcker, Reagan and Friedman here is an excellent interview (albeit anecdotal) that will shed some light on this issue.
http://www.pbs.org/wgbh/commandingheights/shared/pdf/ufd_reaganomics_full.pdf
Volcker, Reagan and Friedman WERE NOT adversarial, they worked TOGETHER to bring the economy back.
Addendum:Interview with Volcker regarding multiple issues
You'll find alot of the information in this transcript great.
http://www.pbs.org/wgbh/commandingheights/shared/minitext/int_paulvolcker.html#6
State your Hypothesis simply in the first or second paragraph, try to use an 'If-Then' or 'Declarative Statement.'
If your goal is to show "the profound influence monetary policy has on shaping our economy" then your article already accomplishes this.
Avoid self-contradictory statements like; "I will challenge some of your assumptions" this statement itself is an 'assumption.'
This is further compounded due to the fact that both factors (ie Reagan's Tax cut and Monetary Policy) were being exercised at the same time.
References from principles sources regarding this issue;
http://www.pbs.org/wgbh/commandingheights/shared/pdf/ufd_reaganomics_full.pdf
Interview with Volcker regarding multiple issues;
http://www.pbs.org/wgbh/commandingheights/shared/minitext/int_paulvolcker.html#6
Your graph of 'GPDI' is terribly inaccurate.
Here is another chart that shows MAJOR growth in GPDI from the years 1980-1990.
http://research.stlouisfed.org/fred2/series/GPDI
"could somebody please explain to me why there was an aggregate decline in investment during the entire Reagan Administration?"
Because you are misinterpreting an extended trend line in a graph that shows 'percentage change' in GPDI.
When using a proper graph to analyze this figure it's clear to see a noticeable RISE in GPDI, the percentage change gives the deceptive illustration that the figure has not risen but it has.
Examining the graph you posted proves this; During the years 1980-1990 there are only two years with a negative percentage change, this was during Reagan's recession when he encouraged Volcker to restrict money supply to get inflation under control.
(This fact is noted by Milton Friedman in PBS interviews)
The other eight years had either positive or virtually no change, averaged WITH the low years its an average INCREASE of +6.38% per year.
Your own graph disproves your assertion.
My hypothesis was clear in the title: "Was it Reaganomics or Monetary Policy?" Attacking grammar and presentation doesn't negate my data. Please stop trying to create a "wedge issues."
My graph is a PERCENT change in GDPI. Do you know what that means? I used percent changes to show how the aggregate investment has moved over time. Because simply showing an upward sloping trend of gross investment could be misleading. In fact it is, because it overstates what is actually occurring. The percent change shows a much more accurate description of the data.
High school algebra should have taught you to read graphs. But I'll explain it a little simpler:
Gross investment during the 1980's was increasing at a DECREASING rate. In other words, people were investing at higher rates in the 1970’s than in the 1980’s.
So no, your conclusion about “MAJOR growth” is what is inaccurate. And this development is contrary to what is told actually happened (in some circles). Also, my GDPI data came from the St Louis Fed (the same place where the rest of the data came from).
And I could tell you without even calculating the percent changes of the 1990’s, that investment rates were much higher under Clinton’s economic policies simply by looking at the slope of the graph.
The S&P 500 is a good indicator about what is going on in the economy. However, stock prices don’t represent things like unemployment. In fact, much of the time it is the opposite. Consider the case of the CEO who lays off workers in order to boost corporate profits and shareholder dividend. The stock price goes up but society isn’t really any better off… And I never said there wasn’t an upswing in the economy. In fact, my whole argument hinges on who generated it. Also, you may want to invest in a Stocks for Dummies book because you’ll learn where Wall Street stock investors take their cues from: The Real Interest Rate…
Now, about the interview with George Shultz... Why am I reading about the Secretary of State weighing in? Reagan gave Volcker the "green light" to do his job? Volcker and indirectly Milton Friedman were on the job before Reagan even won the primary. I showed you how inflation stabilized shortly after Volcker took office and before Reagan was president. It is the Feds job to control inflation, why would Volcker need permission? It sounds like a publicity stunt in the 80's and an irrelevant point in this debate.
And what is your point about this Volcker interview? Did you actually read any of this? Volcker undermines Reagan multiple times throughout this interview.
INTERVIEWER: What was President Reagan's stance toward what you were doing?
PAUL VOLCKER: I saw him from time to time, but I was not a close intimate of President Reagan's. His entourage in the White House, or certainly in the Treasury, were very critical at times. They were... kind of a funny mixture. They had monetarist doctrine, supply-side doctrine, libertarian doctrine all mixed together, so some of it wasn't terribly coherent, which helped me a bit. There was unhappiness because there was a big recession early in his term, and things were not really stable. But he himself never criticized me directly in public, certainly. I always had the feeling that he was urged to do so. [It seemed] that every time he had a press conference somebody was urging him to take a slap at the Federal Reserve, but he never did, and I don't know why. I speculate that he was not a highly sophisticated economist. I'm sure he didn't understand all the arguments his own people were giving him. He did understand that he didn't like inflation, and I think he had some kind of a feeling that the Federal Reserve was trying to deal with inflation.
AHAAHAH
By your own admission, Volcker is quoted as saying Reagan's "Entourage" had economic policies that weren't exactly coherent. Even more amusing, is Volcker's comment about Reagan only having a "feeling" about the Fed trying to take care of inflation. Is he implying that Reagan didn't actually know what the Fed does? I got some good laughs over this interview, but how exactly is this helping your argument that Reagan was responsible for telling the Fed to handle inflation?
Please keep trying to generate an argument. You're stretching for ideas and rationalizations here, but I welcome it. The reality is, supply-side economics isn’t based in reality. The empirical data didn’t support it under Reagan, and it doesn’t support it under Bush Jr.
And please stand by for my blog on of Reagan's tax increases. It will be completed shortly. This will really challenge assumptions! However, I’m sure it’ll just be another feat of futility.
One of these days I’ll get around to talking in depth about banking deregulation and the two major banking disasters that manifested as a result.
Your hypothesis is incomplete, it is not testable and it does not take into account that the tax cuts were active at the same time as monetary policy (Also Reagan's strategy INCLUDED monetary policy, if you insist that the Federal Reserve was independent then it would be Reagan's Administration that started this practice, EVERY administration before him would coerce the Fed into making certain policy adjustments.
The 'aggregate decline' is not a decline at all, you should have said "lower rate of growth", investment continued to grow, even when we assume to only use percentages it grew at an average rate of +6.38% per year, whether it was the rate lower than previous years is debatable but irrelevant to the issue.
Your quote mining is particularly telling. You ignored Friedman's opinion completely and then construed Volcker's view into a with absolutely NO facts to back it up, as I said before these interviews are anecdotal anyway. With this opinion coming from a man that "was not a close intimate of President Reagan's" its understandable that they didn't talk outside a board meeting.
Here is a complete rebuttal of all points that is cited and researched. (Although you'll find any excuse to ignore it.)
http://www.cato.org/pubs/pas/pa261.pdf
Once again, I will state the obvious:
Your graph of the gross accumulation of investments is giving a false picture of growth. Using percent changes gives a more accurate picture of movement. It is commonly used when interpreting macroeconomic trends such as this and is especially critical since we're trying to observe policy impacts.
It's not my fault that you didn't understand the difference between gross and percent change. My graph was clearly labeled and my post started with a disclaimer about the material being wonkish. It was an aggregate decline, it just wasn't in the negative. Investments were increasing at a decreasing rate, remember?
Moreover, the rate of investment isn't "debatable" because the data is all right there. Go to
http://research.stlouisfed.org/fred2/series/GPDI
and run your own analysis. And the rate of investment certainly isn't irrelevant because the tax cuts were justified by claiming they were supposed to spur investment.
I'm not quite sure what you're arguing here or even if you comprehend what these tax cuts were supposed to do. But I’m sorry if the data doesn’t match your ideology. My goal was to challenge your assumptions, remember?
And you're just trying to create a hypothesis wedge issue. You clearly understand what message I'm trying to convey because you're arguing it. If you want to test it, consider the Bush Tax cuts that were very similar and also occurred during a recession. Show me the rate of investment between 1993-2009. I promise I won’t take a sneak peak.
By the way, that’s a great article from the Cato Institute. Next time try to find something that isn't published by a biased think-tank full of sources that mostly point to their previous work. This isn't academic, nice try. Nor does this even have a “rebuttal” for all my points. Do you even read any of these links that you send out? Simply passing out links doesn’t validate your point, especially since you don’t seem to read them.
But I will point out an obvious piece of misinformation in this article (since we’re discussing taxes):
"The Reagan tax cuts were not a primary cause of the eruption of the deficit in the 1980s. The main two causes were an unexpectedly sharp reduction in inflation in the early 1980s that led to large real increases in federal spending, and a nearly $1 trillion military build-up during the last phase of the cold war."
No the tax cuts weren’t the primary cause of the deficit but they certainly didn’t help. Once again, your biased source of information is understating facts. By 1989, Reagan’s two major tax cut Acts had a net effect of -$568 billion. That’s over half of the quoted expense of the military build-up. Want my source? Well you’ll just have to wait for my next post!
thank you
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