I. Understanding Stagflation
A. Keynesian interpretation
1. Inflation and
unemployment change in opposite directions
2. Correlation
existed for four decades and was depicted by English economist
A.W. Phillips in what became known
as the Phillips Curve
a.
He depicted an inverse relationship between changes in wages and changes in
unemployment.
b.
Today the Curve is used to depict changes in consumer prices and unemployment.
c.
The Curve points out the inconsistency of both low unemployment and
low inflation as economic goals.
d. A trade-off between
the two is required because the factors necessary for low
unemployment cause high inflation
and vice versa.
B. Stagflation of the 1970's
1. High unemployment
and high inflation during the 1970's was not easily
explainable with Keynesian theory which emphasized
aggregate demand.
2. High unemployment
caused by low aggregate demand typically results in low
inflation.
3. The Phillips Curve
had moved to the right during the 1970's as both inflation
and unemployment increased.
a.
Prices increased primarily because aggregate supply had decreased
(shifted to the left).
b.
Unemployment increased because of slow growth in aggregate demand.
C. For a dynamic
view of these changes visit
The
U.S. Phillips Curve, 1960-Present from Bradford DeLong's( UC Berkley).
II. The origin of stagflation during the 1970's
A. OPEC monopolized oil prices.
B. Inflationary psychology, the
feeling that prices would always increase substantially,
resulted because of the high inflation
during the Vietnam
War and OPEC price fixing. To some
degree, society acquiesced to inflation.
C. Wage-price controls put on in the
early 1970's to artificially limit the Vietnam War inflation were lifted. Once these
artificial
constraints to market activity were removed, prices increased dramatically.
D. Productivity declined because of an
influx of inexperienced workers (baby boomers and women) and the transformation of
our economy from a
manufacturing base (with its high productivity) to a more
service-oriented base with its low productivity.
III. The misery index, which equals the unemployment rate plus the inflation
rate, is an attempt to measure overall
economic well-being. (Data from 1991 and 2000 Economic Report of the President, 1992 Statistical
Abstract of U.S., Economic
Trends
published by the Federal Reserve Bank of Cleveland and Federal Reserve Estimates. Data was
averaged by the author with
the 1940's average
taken from years 1941-1950, etc.
|
|
|
|
` |
Unemployment Rate |
Inflation CPI-U |
Misery Index |
|
2000 |
4.0 |
3.4 |
7.4 |
|
2001 |
4.7 |
1.6 |
6.3 |
|
2002 |
5.8 |
2.4 |
8.2 |
|
2003 |
6.0 |
1.9 |
7.9 |
|
2004 |
5.5 |
3.3 |
8.8 |
|
2005 |
5.1 |
3.4 |
8.5 |
|
Average |
5.2 |
2.7 |
7.85 |
Analysis: The 7.85 means our
economy is performing and you have to go back to the 1960's for better
performance. Of course it too was a war decade and the 1970's followed.
It was the worst decade in 30 years.
Adding
Short-Term Interest Rates shows an even a larger drop!
Graph is from tuitor2u.com. |
IV. Supply-side economics originated because of stagflation
A. Supply-side
economics described
three key problems causing slow economic growth.
1.
High taxes are the fundamental problem, especially high
marginal rates.
a. They decrease incentive to work and save.
b. They cause cost-push inflation.
2.
High transfer payments lower worker incentives.
3.
Government regulation is expensive and counterproductive.
B. Solving these problems would
stimulate high
noninflationary economic growth by increasing AS.
C. Here is one estimate of the cost of government
regulation.
|
|
|
Total Regulatory Costs (billions of current
dollars)
|
Regulatory Costs per Family (1988 dollars)
|
|
1977 |
433 |
1980 |
5,172 |
|
1981 |
418 |
1984 |
4,458 |
|
1986 |
369 |
1988 |
4,078 |
|
1991 |
400 |
1992 |
4,272 |
From "Regulations' Staggering Costs" by David
Warner, published in Nations Business, June 1992.
Family data
printed in the article from Thomas D. Hopkins, Professor of Economics, Rochester
Institute of Technology. |
D. Visit
Office
of Advocacy - US Small Business Administration - The Impact
for the cost
of regulation.
V. Reaganomics
A. President Reagan attempted to
eliminate the causes of stagflation by instituting
supply-side economic policies.
B. These were the key ingredients of President
Reagan's economic policy.
1. Supply-side
policies
a.
Lower government expenditures on social programs
b.
Reduce government regulation
c.
Cut personal and corporate taxes, especially high marginal
tax rates
2. Monetary
policy:
President Reagan did not discourage the Federal Reserve from their continued attempt
to
lower inflation with a tight money policy.
C. Keynesian economics predicted lower taxes would
increase the already high rate of inflation.
D. Many predicted high deficits, economist Arthur Laffer disagreed.
1. Laffer Curve
2. Lowering the tax rate from X to X' would
increase tax receipts.
a.
Lower tax rate would lessen avoidance of taxes.
b.
Fewer transfer payments due to tougher welfare policies would result in more
people working and paying taxes.
c.
Overall effect of the program would be higher productivity. This would increase
AS causing GDP and tax revenue
to increase.
VI. Analyzing the effectiveness of Supply-Side Economics as applied by
Ronald Reagan
A. Contractionary effects
of tight money came earlier than the expansionary effects of a tax cut and the
result was two
recessions from 1980-83.
B. Short-term results were
good.
1.
Inflation dropped dramatically although much of the credit must
go to the Federal Reserve which began tightening
in 1979.
2.
Unemployment eventually came down.
3.
The longest peacetime expansion in history resulted although critics point out
that the large increase in military
spending during
the early Reagan years made for high peacetime defense budgets.
C. Supply-side effects may have
been negligible.
1. Aggregate supply moved little as
productivity increases were small.
2. Saving went down (though much of the
drop in saving had demographic causes as baby boomers
borrowed
to furnish homes, many of which were investment type
multifamily dwellings.
D. Some results seemed bad,
especially at the time.
1. Large federal deficit resulted
(in part because inflation came down much faster than
expected lowering tax revenues).
Many felt these
deficits
would compete with (crowd out) private investment for many
years.
2. The trade deficit increased.
a. The problem began when an increase in borrowing by businesses, individuals, and
the federal government caused
high interest rates.
b. High interest rates combined with a drop in inflation and an economic
recovery making U.S. investments attractive.
c. The resulting high foreign
demand for the dollar pushed its value up making imports cheaper and exports
more
expensive.
E. Opinions differ as to the overall
result.
1. Some think the recovery was a
typical Keynesian demand-side phenomenon (i.e., deficit
spending)
2. Supply-side economists point to
a number of improved conditions.
a. The
increase in manufacturing productivity indicates supply-side
economics worked.
b. Comparing saving rates for countries is difficult as
different accounting procedures are used to measure saving.
c.
When Reagan left office, the average United States
citizen earned about 25% more than the average citizen of
Germany and Japan.
1. Data based upon purchasing power parity and not the
international exchange rate of the dollar.
2. Critics point to a widening income
gap between rich and poor.
3. Other things happened that
affected economic activity.
a.
Industry was deregulated.
b. Intellectual
Property rules were rewritten.
c.
Pressure was put on the Soviet Union by enhancing the military buildup started by
President Carter.
d.
Striking air traffic controllers were fired.
e.
Social Security funding was enhanced with benefit cuts and tax increases.
f. The
government increased dramatically funding semiconductor and network research.
g.
These thoughts are from page H2 of the article by David Warsh in the February 4,
2001 Boston Globe.
VII. Recent tax reforms
1. Economic
Recovery Tax Act of 1981
a.
Cut personal tax rates by 25% over three years
b.
Reduced capital gains tax rate below that paid on ordinary income
c.
Allowed for a more rapid write-off of capital (accelerated depreciation)
2. Tax Reform
Act of 1986
a.
Lowered top rates from 50% to 28%
b.
Increased the tax base by doing away with many tax loopholes
3. Budget Accord of
1990
a.
Increased the top tax rate to 31%.
b.
Increased regressive excise taxes.
4. Tax Increases of 1990 and 1993
a. Taxes were
increased to lower the deficit.
b. Hope was a lower
deficit would lower interest rates.
c. Interest rates came down,
other things happened to foster a strong economy, and the deficit (ignoring the
long-term
social security liability) disappeared.
5.
Economic
Growth and Tax Relief Reconciliation Act of 2001
and the 2003
a.
highest income tax rates: the 28, 31, and 36 percent rates fall by 3 percentage
points, while the 39.6 percent rate falls to 35 percent.
b. A
new 10 percent tax bracket is carved out of the 15 percent bracket.
c.
Although the cuts in the highest income tax rates phase in slowly, the 10
percent bracket is available immediately.
d. The
tax act also expands the child credit and the Earned Income Tax Credit (EITC)
e.
reduces marriage penalties
f.
increases subsides for education and retirement saving
g.
repeals the limitations on itemized deductions and phaseouts of personal
exemptions
h.
provides temporary, limited relief from the alternative minimum tax (AMT), a
complex law that was designed
to prevent aggressive tax sheltering but primarily affects large families or
residents of states with high income taxes.
i. The
tax act reduces the estate tax and generation-skipping tax between 2001 and 2009
and repeals them in 2010.
j.
Different views of the act
1)
2001 Tax Cut
takes an in depth look.
2)
CTJ May 26 Analysis of Final Bush Tax Plan
3)
The 2001 Tax Cut Did Make a Difference
is what most conservatives feel 5
years later.
4)
The Tax Foundation - Comparing the Kennedy,
Reagan and Bush Tax Cuts
4)
Tax
Returns: A Comprehensive Assessment of the Bush Administration
...
6. Jobs and Growth
Tax Relief Reconciliation
Act of 2003
a.
Lowered long term (over one year) capital gains
taxes from 20% to 5% for those in the lowest two brackets (Under $65,100 for
married filing jointly in 2008) and 15% in higher brackets.
b.
Most rate reductions would expire if not extended
by 2010.
c.
Primary residence is excluded to $250,000 ($500,000
married filing jointly) if held two of the five years prior to the sale.
d. See
Jobs and Growth Tax Relief Reconciliation Act of 2003
for a more complete description of this complicated law.
VIII. The future = Savings + Investment + Risk Taking = Productivity
