Supply-Side Economics “Reaganomics,” Monetarism, and Military Keynesianism

Supply-Side Economics

“Reaganomics,” Monetarism, and Military Keynesianism

Cornerstones of Supply-Side Economics in the 1980s

1) supply-side tax cuts for business to provide incentives for firms to produce, and tax cuts for households to promote the incentive to work in the labor market


2) Shift in the composition of government spending away from social programs (including job training and education) to military spending—but no net decrease in government spending


3) Contraction of the money supply to fight inflation—supply-siders in the early 1980s accepted the monetarist view of the quantity theory insofar as there being a direct relation between M and P.


4) Deregulation of industry and financial institutions—to cut costs, promote efficiency, and remove cumbersome laws and regulations.


5) Don’t worry about demand, Say’s Law holds.

Say’s Law—

“supply creates its own demand”

SUPPLY-SIDE ECONOMICSyear GNP deficit tax cuts trade deficit notes1981 (Ms contracted to fight inflation; i rise 23.5%)1982 -2.5% $128b 5% $ 38.4 U x 2 to 9.5% 1983 +3.6% $208 10% $ 64.2 9.5% unempl.1984 +6.0% $185 10% $122.41985 +3.3% $212 $133.61986 +2.7% $221 $155.11987 +3.4% $150 $170.31988 +4.4% $155 $137.11989 +2.5% $153 $129.41990 +1.0% $220 $123.41991 -. 7% $269 $ 86.3

supply-side in the 80s

• 1981: Reagan entered office in 1981- first attacked inflation: anti-inflationary measures are policies that favor creditors over those in debt

• money supply was sharply contracted- Supply siders are monetarists when it comes to monetary policy; both monetarists and supply-siders are neoclassicals- did bring inflation under control - monetarist would say because of direct relation between M and P; but what would Keynes say happens when M supply is contracted? Interest rates should go up? In fact, interest rates shot up 23.5%!


• 1982: GNP fell 2.5% as unemployment nearly doubled until 12 million officially out of work. Reagan tax cuts begin (5%), and deficits increase by over 64% or $50b to over $128b. Biggest recession since before WWII (up to that time).


• 1983: GNP rises 3.6%, but that is just 1.1% increase in output from two years previous- deficit expands 62.5% to a whopping $208 billion (almost triple from when Reagan entered office) as more tax cuts (10%) and trade deficit rises 67% from $38.4b to 64.2b. No improvement in unemployment- still 9.5% unemployed.


• 1984: so-called 'recovery' GNP rises by 6%, but another $185b deficit; and trade deficit up 90% to $122.4b. Another 10% tax cut leading to another $433b in deficits in next two years.

Supply-Side Economics

• Logic of Supply-Side Tax Cuts:

-Tax cuts for workers give them an incentive to work, work harder

and work more hours.

- Tax cuts for businesses means firms will invest and produce more.

Supply-Side Tax Cuts—Workers

• Problems: After-tax income is important to workers. But it is only one -- a very important one, but nevertheless only one -- part of total job satisfaction. Job security, work environment, many other factors are also important, as numerous studies have shown. What is happening to the job security index when unemployment shoots up to double digits in the Reagan recession? What is happening to the work environment index when deregulation kicks in? Moreover, to enjoy the incentive of take home pay, you have to have some pay to take home, and so these incentives mean nothing for the unemployed.

Supply-Side Tax Cuts—Firms

As far as businesses, again we go back to Keynes's emphasis on expected profitability. It doesn't matter if taxes are smaller, if expectations are dimmed because of a recession and unemployment, firms aren't going to be increasing productive capacity. They aren't able to sell all they can produce now. A capital gains tax cut does nothing to guarantee investment. An investment tax credit may help a little more, at least then there is some incentive to invest.

Supply-Siders and Say’s Law

For both these cases, supply doesn't create its own demand. Supply-siders are adherents to Say's Law, but Say’s law means production generates income sufficient to purchase that output—the national income accounting identity—but does not guarantee that all production will in fact be purchased.

costs and revenues

Lower costs for one is lower income for others—in this case with the tax cuts, much of that lower income resulted in lower tax revenues for government—look at what happened to the budget deficit following the tax cuts.

Reaganomics—the legacy

But then what about the Reagan recovery? From 1982-84 there were over $520b in deficits—that's fiscal stimulus. The so-called recovery was demand side, not supply side. One indicator that this is so is the fact that there was inflation in this period. See this with AS-AD analysis.

Reagan Recovery—supply or demand side expansion?

P

Y

P*1

Ye*1

0

AD1

AS1

AS2

P*2

Ye*s


If the recovery was supply-driven, then there should be an increase in output with steady or falling prices. If the expansion was demand-driven, output and prices would both rise.


P

Y

P*1

Ye*1

0

AD1

AS1

P*2

Ye*s

AD2

Reagan Recovery: why didn't it last?

1) This was military Keynesianism- the tax cuts combined with no decrease in G but a shift in the composition of spending to military expenditures gives us a multiplier effect but a low one—there is no inner growth dynamic to military spending.

Reagan Recovery: Why didn't it last?

2) redistribution of income from poor to rich meant redistribution from those with a higher mpc to those with a lower mpc—and so a lower multiplier.

Reagan Recovery:why didn’t it last

3) booming trade deficit—without a full employment policy, this becomes a problem, because reverse multiplier effect—declining competitiveness in US manufacturing, refusal to try to limit capital flight, protect domestic industry

Reaganomics: why didn’t it last?

4) deregulation of the banking system—led to S&L crisis; $500 billion + taxpayer bailout

Reaganomics: problems

5) contrary fiscal and monetary policy—expansionary fiscal, anti-inflationary monetary…


6) decline in infrastructure and

education/skill level of the labor force


1990-91—Worst recession since WWII up to that time.

End of supply-side

• End of the supply-side era: $4.2 trillion debt run-up (from $1.1t $5.3t

• unstable banking system

• over official 7.5% unemployment

Clintonomics

• With the run-up of the national debt, Democrats took a political strategy of trying to call the Republicans fiscally irresponsible. The Democrats were very upset about deficit dove positions that said deficits and the debt were ok. They didn't want to hear that deficits weren't a problem and maybe they were even good sometimes and we shouldn't fret over the debt. So that by the end of the eighties, the two parties are both claiming to be the 'really' fiscally responsible one, against those terrible deficits and the national debt, and any common sense that had been represented in the mainstream policy debate vanishes into thin air.

Reaganomics and “Big Government”

Several Reagan advisors reveal that the Reagan administration purposely ran up deficits and the debt to try to bankrupt big government—tax cuts leading to big deficits were the only path to “downsizing” big government.

“It’s the Economy, Stupid!”

A key part of "It's the Economy Stupid!" Economics is budget balancing, deficit reduction. The deficit did fall; the budget even moved into surplus. But that was not the cause of the Clinton expansion, it was the result of rising incomes and the automatic stabilizers. By the turn of the century we have Al Gore running on paying down the debt, surplus uber alles, and putting money in a “lock-box.” The private sector is racked with debt, and the U.S. circa 2000-2001 looked more and more like Japan in the early 90s, where interest rates at zero for years did nothing to stimulate the economy.

Tweedle-dee and Tweedle-dum

Debates over issues like social security are fraught with fallacies and misunderstandings concerning the modern money system and budgetary and employment policy. Republicrats and Demublicans alike do not understand modern money or functional finance.

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Supply-Side Economics “Reaganomics,” Monetarism, and Military Keynesianism