Chapter 16 Stagflation and the Rise of Supply-Side Economics 9/3/16

I. Understanding Stagflation  Low 1970's Aggregate Demand as expected caused slow growth but it did not slow increasing inflation.
II. The origin of stagflation during the 1970's Vietnam War deficits, two oil embargos and low productivity led to low growth with inflation.
III. The Misery Index  Unemployment + inflation up from 7.5% in 1960's, to14.3% in 1970's, 11.8% in 1980's and a more normal 8.7% in 1990's. For 8/16 it was 5.7%.
IV. Supply-side economics originated because of stagflation It stated high taxes increased government regulation lowered productivity and investment.
V. Reaganomics
cut taxes and regulations and he let the FED kill inflation resulting in the first Great Recession in the early 1980's.
VI. Effectiveness of Reagan's Supply-Side Economics
It worked or was it large Keynesian deficits?  See U.S. Economic Normality 1945-2015

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.
            e. The Phillips Curve Key Concepts in 60 seconds video
            f. Will the Real Phillips Curve Stand Up  04/04/11
            g. The Phillips Curve Timelessly Misleading 10/19/14

Edmund Phelps and the Phillips Curve

 

Martin Wolf 1

   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 AS had decreased (shifted left).
          
b. Unemployment increased because of slow growth in aggregate demand.
   C.
The current and historical Misery Index
   D. Check out AP Macroeconomics Review Materials!

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.

 

 

 

Misery Index by Year

(1948 to 2010)

Unemployment Rate
By Year (1948 to 2010)

Inflation Rate By Year (1948 to 2010)

U +

 I =

MI   
2001 4.76 2.83 7.59
2002 5.78 1.59 7.37
2003 5.99 2.27 8.26
2004 5.53 2.68 8.21
2005 5.08 3.39 8.48
2006 4.63 3.24 7.87
2007 4.61 2.85 7.46
2008 5.76 3.85 9.61
2009 9.26 -0.34 8.29
2010 9.64 1.64 11.29

Misery index from - Wikipedia has interesting information.

Getting Better Since 2010

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. This would stimulate high noninflationary economic growth by increasing AS. 
      C. Here is one estimate of the cost of government regulation.
      D. For the cost of regulation visit 
Office of Advocacy, U.S. SBA, The Impact

Image result for Stagflation Cartoons

  Image result for cost of Regulation data

Image result for cost of Regulation data

Editors Note: Material supplied by anti-regulation advocates.

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.
        3.
The  Laffer Curve- Economic Theories in 60 seconds

Image result for Supply Side Cartoons

 


 

VI. Effectiveness of Reagan's Supply-Side Economics
      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.

 
     
Image result for Supply Side Cartoons

F. 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 0 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
                 phase outs 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 reduced 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)
Comparing Kennedy Reagan, Bush tax-cuts
                 5) 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.

VII. The future = Savings + Investment + Risk Taking = Productivity

VIII. Readings
 
     A.
Historic Review of government action to stop recessions from the NYT
       B.
Supply-side Versus Keynesian Economics 8/18/14

 

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