All Terrain Thinking

A Compendium of things I think are Important

Economics: It's not just whats' in your wallet

1980s: Reaganomics

The Setting

"All of the legislation in the world can't fix what's wrong with America.  It is a crisis in confidence.  It is a crisis that strikes at the very heart, soul, and spirit of a national will ... and it is threatening to destroy the social and political fabric of America." _{Jimmy Carter August, 1979}

"long after the Pope is gone, you'll remember this."  _{Federal Reserve Public Affairs Director, 1979}

"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'?" _{Ronald Reagan, presidential campaign}

"I regret to say that we are in the worst economic mess since the Great Depression." _{Ronald Reagan New York Times Feb 6, 1981}

"The federal government is, in general, too big, taxing too much of the wealth of Americans, doing too many unnecessary and often counterproductive things that get in the way of economic growth, to say nothing of personal liberty." _{"Conservatism at Century's End in Policy Review Ap/ May 1999 p 3}

"'Thatcherism' can only be avoided if the initial economic policy package simultaneously spurs the output side of the economy and elicits a swift downward revision of inflationary expectations in the financial markets...

President Reagan should declare a national economic emergency soon after inauguration. He should tell the Congress and the nation that the economic, financial, budget, energy, and regulatory conditions he inherited are far worse than anyone imagined.  He should request that Congress organize quickly and clear the decks for exclusive action during the next 100 days on an Emergency Economic Stabilization and Recovery Program he would soon announce." _{Stockman-Kemp paper "Avoiding a GOP Economic Dunkirk}"

"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." _{Ronald Reagan State of the Union Message Feb 18, 1981}

"The edifice [Supply-side Economics] was delicately balanced on a set of simultaneous policy actions and a set of equations describing the effects of the policy actions on the economy." _{Herbert Stein in Presidential Economics p 267}

"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 that these policies could be rejected without also rejecting many conservative objectives or totems. " _{Herbert Stein in Presidential Economics p 236}

"Let's tell the truth. Mr. Reagan will raise taxes, and so will I.  He won't tell you.  I just did."  _{Walter Mondale in 1984 presidential campaign}

"Read my lips...NO new taxes". _{George Bush during presidential election in 1988}

""The success or failure of any country over the next thirty years hinges on growth." _{Hamish McRae The World in 2020 p 3}

"Of all the forces that will change the world over the next generation, demography is probably the most important" _{Hamish McRae The World in 2020 p 97}

"Productivity isn't everything, but in the long run its almost everything." _{Paul Krugman, The Age of Diminished Expectations p 9}

Diagram 1
Macroeconomic Performance in the 1970s

Diagram 2
Federal Government Finances

Diagram 3
Federal Government Receipts

Diagram 4

Diagram 5

Diagram 6

Questions of the day

1. Are we ready for a little more complication in your macro model? One reason to do it is that it allows us to help explain the emergence of Ronald Reagan on the national political scene. He seized the moment, he identified the 'wave' of public sentiment and rode it into the White House. The problem was that there was no leadership on the economy which was suffering through a second case of stagflation within a decade?  What was the problem that he proposed to fix? Please demonstrate the situation with AS-AD diagrams.

2. And how did he propose to solve stagflation? Identifying the problem is only half the battle. What can we do to solve the problem? What was the name given to his 'package' of reforms designed to right the course of the American economy? Please use the diagrams from class to demonstrate the Reagan solution to our problem.

3. Ronald Reagan led a revival of the conservative movement in the presidential election of 1980. What were the three key pieces of the conservative agenda and what were the problems associated with the achievement of each one?

4. George Bush called Reagan's economic policies "voodoo economics" while Herbert Stein called them "the economics of joy." Both individuals were reacting to Reaganomics' painless solution to stagflation. What were the roles of the Arthur Laffer and Robert Lucas in Reagan's solution?

5. Output in an economy can be expanded by increasing the level of resources or the productivity of those resources.  What were the 'pieces' of Reagan's economic package and how did they all work together to increase the supply of resources and productivity?

6. Please explain the significant differences between the inflation caused by the military build-up for Vietnam in the late 1960s and the inflation caused by the OPEC price increase in the early 1970s.[you may want to use the AS-AD model].

The outline

• An environmental scan
  • economic policy / theory
  • political / social
• Conservative agenda
  • reduce inflation
  • reduce size of government
  • eliminate budget deficit
• Difficulties with agenda
  • painful disinflation
  • painful loss of programs / benefits
  • no tax cuts
• Reagan solution
  • waste
  • rational expectations
  • Laffer curve
• Reagan policies
  • to increase capital
  • to increase labor
• Impact of Reaganomics
  • domestic economy
  • international economy
  • government
    • deficit / debt

The problem

Diagram 7
Adverse Supply Shock

Diagram 8

The solution

Rational expectations

Adaptive expectations I

i₊₁ = i

Adaptive expectations II

i₊₁ = i + (i - i_-1 )

Rational Expectations

i₊₁ = m

Diagram 2
Phillips Curve II

Laffer curve

D = G - T

The Laffer Curve

The consequences

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