Bruce Bartlett: How Supply-Side Economics Trickled Down

Bruce Bartlett says we're all supply-siders now, but as explained in some detail below, I don't fully agree:

How Supply-Side Economics Trickled Down, by Bruce Bartlett, Commentary, NY Times: As one who was present at the creation of “supply-side economics” back in the 1970s, I think it is long past time that the phrase be put to rest. It did its job, creating a new consensus among economists on how to look at the national economy. But today it has become a frequently misleading and meaningless buzzword that gets in the way of good economic policy.

Today, supply-side economics has become associated with an obsession for cutting taxes under any and all circumstances. No longer do its advocates in Congress and elsewhere confine themselves to cutting marginal tax rates — the tax on each additional dollar earned — as the original supply-siders did. Rather, they support even the most gimmicky, economically dubious tax cuts with the same intensity.

The original supply-siders suggested that some tax cuts, under very special circumstances, might actually raise federal revenues. For example, cutting the capital gains tax rate might induce an unlocking effect that would cause more gains to be realized, thus causing more taxes to be paid on such gains even at a lower rate.

But today it is common to hear tax cutters claim, implausibly, that all tax cuts raise revenue. Last year, President Bush said, “You cut taxes and the tax revenues increase.” Senator John McCain told National Review magazine last month that “tax cuts, starting with Kennedy, as we all know, increase revenues.” Last week, Steve Forbes endorsed Rudolph Giuliani for the White House, saying, “He’s seen the results of supply-side economics firsthand — higher revenues from lower taxes.”

This is a simplification of what supply-side economics was all about, and it threatens to undermine the enormous gains that have been made in economic theory and policy over the last 30 years. Perhaps the best way of preventing that from happening is to kill the phrase “supply-side economics” and give it a decent burial.

It’s important to remember that at the time supply-side economics came into being, Keynesian economics dominated macroeconomic thinking and economic policy in Washington. Among the beliefs held by the Keynesians of that era were these: budget deficits stimulate economic growth; the means by which the government raises revenue is essentially irrelevant economically; government spending and tax cuts affect the economy in exactly the same way through their impact on aggregate spending; personal savings is bad for economic growth; monetary policy is impotent; and inflation is caused by low unemployment, among other things.

These beliefs led to many bad economic policies. In particular, they lay at the root of stagflation, that awful combination of high inflation and slow growth that bedeviled policy makers in the 1970s. Based on insights derived from the Nobel-winning economists Robert Mundell, Milton Friedman, James Buchanan and Friedrich Hayek, the supply-siders developed a new program based on tight money to stop inflation and cuts in marginal tax rates to stimulate growth.

As the staff economist for Representative Jack Kemp, a Republican of New York, I helped devise the tax plan he co-sponsored with Senator William Roth, a Delaware Republican. Kemp-Roth was intended to bring down the top statutory federal income tax rate to 50 percent from 70 percent and the bottom rate to 10 percent from 14 percent. We modeled this proposal on the Kennedy-Johnson tax cut of 1964, which lowered the top rate to 70 percent from 91 percent and the bottom rate to 14 percent from 20 percent.

We believed that our tax plan would stimulate the economy to such a degree that the federal government would not lose $1 of revenue for every $1 of tax cut. Studies of the 1964 tax cut showed that about a third of it was recouped, and we expected similar results. Thus, contrary to common belief, neither Jack Kemp nor William Roth nor Ronald Reagan ever said that there would be no revenue loss associated with an across-the-board cut in tax rates. We just thought it wouldn’t lose as much revenue as predicted by the standard revenue forecasting models, which were based on Keynesian principles.

Furthermore, our belief that we might get back a third of the revenue loss was always a long-run proposition. Even the most rabid supply-sider knew we would lose $1 of revenue for $1 of tax cut in the short term, because it took time for incentives to work and for people to change their behavior. ...

Moreover, we were adamant that only permanent cuts in marginal tax rates would stimulate the economy. We thought that temporary tax cuts, tax rebates, tax credits and such were economically worthless, and we strongly opposed them.

Today, hardly any economist believes what the Keynesians believed in the 1970s and most accept the basic ideas of supply-side economics — that incentives matter, that high tax rates are bad for growth, and that inflation is fundamentally a monetary phenomenon. Consequently, there is no longer any meaningful difference between supply-side economics and mainstream economics.

There is no question in my mind that we never could have overcome the stagflation of the 1970s as quickly or with as little pain as we did without the supply-side idea. But supply-side economics has done its job, just as Keynesian economics did in the 1930s. Those who campaign as its champions are fighting a fight long won — and it is time for supply-side rhetoric to go, with its essential truths embodied in mainstream economics and its perversions discarded for good.

As noted above, I don't fully agree, so let me cast this debate in a different framework where it's easier for me to highlight where we differ.

Let's start with the following fairly standard picture of the evolution of GDP. The red line shows actual output cycling over time, and the blue line shows that natural rate of output which also varies over time:

As depicted, the natural rate is subject to both permanent and temporary supply shocks causing growth to be uneven, but generally upward, and actual output is driven away from the natural rate by demand shocks. That is, the variation in the blue line is from supply-shocks, and the deviation of the red line from the blue line is from demand shocks.

In general, there are two types of policies to consider. The first is the use of monetary and fiscal policy to stabilize the economy. The goal here is to use changes in the money supply, government spending, and taxes to manage aggregate demand and minimize the deviations of actual output from the natural rate of output. This is shown by the dotted red line in the following diagram which is closer, on average to the natural rate than the no-policy outcome shown as the solid red line:

The second type of policy is growth policy. This is what many people mean when they use the term supply-side policy. The goal here is to increase the growth rate of output. This is shown by the upward rotation of the trajectory for the natural rate in the following diagram:

The natural rate of output is determined by the growth of technology, the growth of the capital stock, and the growth of the labor force so policies to increase the growth rate of output are directed at these factors. Examples of supply-side policies are (not all have proven to be equally effective, or effective at all in some cases, and this is far from exhaustive) tax breaks for research and development (to increase technology), tax breaks for IRAs (to increase saving, investment, and the capital stock), tax cuts on capital gains and dividend  (to make capital markets more efficient and increase the capital stock), spending on education (to make labor more productive), reductions in marginal tax rates (so people will increase work effort), accelerated depreciation (to make investment cheaper and increase he capital stock), and reductions in estate taxes (so people will work harder to leave more for their heirs).

Note also that it is the upward rotation in the supply-curve that generates the increase in taxes from supply side policies that you often hear about. The question, of course, is how much additional growth comes from a cut in taxes and here I agree to some extent with Bruce Bartlett. It depends upon the type of tax cuts that are enacted, some are more productive than others and hence some types of tax cuts generate more tax revenue than others. Whether the tax cut is permanent or temporary is also important.

We'd disagree over the magnitude however. While some types of tax cuts can affect growth, the effect is nowhere near large enough to generate a 33% tax revenue recovery rate, not even close, and, in any case, all the low-hanging fruit has already been plucked, something that is often overlooked.

That is not the end of our disagreement. Bartlett does not distinguish between various classes of models, between the short-run and long-run, or between stabilization and growth policy all of which are important distinctions so let me touch upon these issues.

There are two predominant views of the source of fluctuations in output, Real Business Cycle models and New Keynesian models.

Real Business Cycle (RBC) theorists believe that most if not all fluctuations in the economy are due to supply side shocks, aggregate demand shocks such as changes in the money supply, changes in taxes, and changes in government spending affect nominal variables such as prices but have little to do with changes in output over time (however,  government intervention does causes inefficiencies in these models so that less intervention is generally preferred to more). Thus, for RBC advocates, the red and blue lines lie nearly on top on one another because nearly all of the movement in output is due to supply shocks.

Obviously, then, in these models demand management - monetary and fiscal policy - can stabilize prices (and hence increase efficiency), but demand management has little effect on output.

Thus, since short-run demand management is ineffective in these models (and often counterproductive), all that's left is long-run growth policy and that's why people such as Bruce Bartlett, who have an RBC model in mind when thinking about policy, tend to focus on long-run, supply-side, growth enhancing policies.

Let me turn next to Keynesians. My focus is on the New Keynesian (NK) school, but I should note that I don't agree with all of the characteristics Bartlett associates with Keynesians of the 1960s and 1970s, and I certainly don't agree with the claim made in the next paragraph that after the policy failures of the 1970s "the supply-siders developed a new program based on tight money to stop inflation and cuts in marginal tax rates to stimulate growth." A standard expectations augmented Phillips curve story does a much better job of explaining these events, and the interest rate targeting rules used from the early 1980s onward are not based upon RBC models. Most RBC models don't even include money as it plays not role in either the short-run or long-run.

New Keynesians (NK) do not deny that shocks to aggregate supply can affect GDP nor that supply shocks can be large and important. However, New Keynesians also believe that aggregate demand shocks are important, i.e. that the difference between the blue and red lines is large.

New Keynesians attempt to stabilize actual output around the natural rate as shown above. Why does NK policy tend to focus on demand shocks rather than supply shocks? The answer is that although it would be ideal if we could use supply-side polices to smooth short-run fluctuations in output arising from supply shocks, the reality is that we cannot do this. As Bartlett notes, supply-side polices are very blunt, slow-acting policies that can affect output in the long-run, but they are all but useless in dealing with short-run fluctuations in the economy (thus, RBC theorists tend to focus mainly long-run growth).

Since supply cannot be managed in the short-run, that leaves demand management policies, i.e. monetary and fiscal policy. As we learned in the 1970s, demand side tools are not very effective instruments for offsetting supply-side shocks - trying to use demand side policy to offset supply shocks helped to generate the stagflation we saw at the time. We've learned since then, but practically we are still somewhat powerless to offset supply side shocks in the short-run - all we can do is manage demand to match changes in supply. That is, if a hurricane wipes out supply, we can use policy to reduce demand to match, but we can't do much to increase supply back to its initial level in the short-run.

What we can do much more effectively, if you believe in NK models, is stabilize demand shocks through demand management policy. These policies are relatively simple conceptually, the trick is to manage demand so that upward and downward demand shocks are offset by appropriate changes in policy, but that is easier said than done. Still, we do appear to be able to reduce variation over time through both monetary policy in particular, and also through fiscal policy (e.g. through automatic stabilizers).

The claim made by Bruce Bartlett that "there is no longer any meaningful difference between supply-side economics and mainstream economics" is not something I can agree with. There are big differences between the RBC and NK schools and big differences in the implications of the two schools for policy in the short-run. RBC advocates do not believe in short-run stabilization policy, their focus is solely on maximizing long-run output growth. NK theorists do not deny that robust economic growth is important, but they also believe that government can play a helpful role is smoothing short-run economic fluctuations.

Why do Republicans tend to endorse the RBC framework? I believe in many cases that belief in the RBC model arises from an honest view that the evidence is most supportive of this class of models. But in other cases I believe it is an ideological marriage. The RBC model has two features that make it attractive.

First, because it says short-run stabilization policy is ineffective, and that government intervention through either spending or taxes generates economic distortions, the RBC framework supports an approach where the role of government in the economy is minimized.

Second, because the RBC framework allows for tax cuts to produce higher growth by reducing inefficiencies, and because it is then possible to argue that tax revenues might increase, it gives two reasons for supporting tax cuts - higher growth and less than a full loss of tax revenue, i.e. a dollar tax cut does not cost a dollar (or, for serious ideologues, the tax-cuts even pay for themselves).

The NK model, on the other hand, supports active government intervention which is at odds with this ideology. In addition, because the focus in NK models is on stabilization of output around the natural rate, not on growth of the natural rate, tax-cuts do not have the dynamic long-run effects as in RBC models (though these can be added) and hence there is not as much ideological support for tax cuts in the NK framework.

This is much too long already, but a few more things. We don't we know which type of shock is most important? If demand shocks play a substantial role, we should pay attention to the NK policy prescriptions, but if aggregate supply shocks are the primary force behind business cycles, we should abandon short-run stabilization and focus solely on long-run growth. We don't we just look at the empirical evidence and figure this out?

The problem, essentially, is that we only have one time-series, GDP, and we want two things from it, supply shocks and demand shocks. Since we only have one piece of information and want two things from it, we must make an assumption of some sort. Under some assumptions, supply shocks appear predominant, but under others, demand shocks are the most important factor in business cycles. Because we have no way of knowing for sure which assumption is best, and because the econometric evidence changes as the assumptions change, we are left with uncertainty as to which type of shock matters most and hence which model we ought to prefer.

There is much more to say about all of this, I haven't even mentioned New Classical models, but that will have to do for now. Summarizing, contrary to what is implied in Bruce Bartlett's commentary, there are two distinct schools in economics, the RBC school and the NK school, and they have very different policy implications. Not everyone will agree with this, and that is the point I suppose, but I would argue that the mainstream view today is the NK model, though the RBC school has strong advocates and has made important contributions to our thinking (the long-run incentives Bruce Bartlett mentions are a good example).

So, here's where we agree. Both NK and RBC advocates see the long-run similarly. Both schools agree that demand side polices have little effect on long-run growth. Both agree that incentives matter, and that we should, of course, strive to enhance efficiency and long-run growth whenever possible. There is a difference in the two schools as to the strength of those incentives, but if that is all that is meant by supply-side polices, then fine, no problem, we're in agreement.

But there is a big disagreement over the short-run. RBC adherents take a hands-off, free market approach. Their model tells them that government interference causes inefficiencies, and that there is nothing to be gained in return in terms of enhanced stability. NK adherents believe government should take an active role in stabilizing the economy and that is something that, contrary to what is implied above, has not changed since the 1960s and 1970s. The model used by the NK school is very different from the models we used then - and our approach to policy is similarly different - but the basic idea that government intervention can help to stabilize output and employment in the short-run is unaltered.

Update: See comments by Bruce Bartlett and Paul Krugman.

Update: More at Angry Bear, Political Animal, Ezra Klein, Angry Bear again, Division of Labour, and Tim Worstall. Update: Brad DeLong too. . Update: One more from Angry Bear. Update: Lawrance Lux comments. Update: Angry Bear with more. Update: Talk Left also.

Update (4/11): Follow-up here.

Comments

[Bruce Bartlett]

Interesting discussion. However, I think Mark misses the historical context of my analysis. In the 1970s, we were unaware of real business cycle theory or New Keynesian theory. We were confronting Old Keynesian theory. What Mark has basically done is take a current theoretical debate and superimposed it on the 1970s. That's fine if one's goal is to understand how the economy really worked in the 1970s or what the actual effects of policies taken at that time were. But as a matter of history, it is misleading. We didn't know any of this stuff because it didn't exist then. We were dealing with a far different situation in terms of what people knew about the economy (or thought they knew) and that's one reason why I believe that terms like "supply-side economics" have outlived their usefulness. The context in which the term had meaning no longer exists and therefore it has become a barrier to communication rather than a facilitator.

[anne]

An awfully nice exchange, and possibly an exchange that might be broadly possible in time. Nice indeed. I could not be more thankful for Bruce Bartlett's thoughtfulness, flexibility and courage.

[Blissex]

I think that Bruce Bartlett here is being a bit of a revisionist, but his conclusions are sounder than that. In the 50s-60s the new-Keynesian betrayal of Keynes was that output problems were essentially always an issue of insufficient demand, a position of extraordinary faith in the markets. The idea was that markets would provide plenty if only insufficient demand traps were avoided. In hindsight that was ridiculous, and the idea that excessive levels of distorting taxation were stifling the operations of the markets, not just insufficient demand, was sound, and that it is now widely accepted is good, as the markets cannot simply adjust to any conditions except insufficient demand. I think however that Bruce Bartlett's memories are gravely wrong in two ways: * He compares the ''realistic'' supply siders of the 1970s with the delirious ones of today, but in the heat of political discussion the claims of many influential 1970s supply siders were as extreme as today's, including Reagan's. * The great inflation of the 1970s was not cured by supply-side economics, but simply by a change of political objectives. Inflation was as always solely a political phenomenon, the consequence of seignorage. In the 1960s policy was butter-and-guns, and to increase social stability in difficult times with a policy of easy, easy money, favouring debtors and holders of real assets with very low interest rates. In the 1970s politics reversed, as the Vietnam war was wound down, and Volcker implemented a ferocious policy of high interest rates, favouring creditors and holders of financial assets. Very, very little to do with supply side economics.

[ken melvin]

I see supply side, monetary policy and trickle down economics as different animals. Doing one and calling it another, is suspect. In fact, how did trickle down get in there at all?

[Callahan]

What comes down on me comes not as a trickle, and not as money. On the contrary, it comes with a force of white water rapids, and it is liquid, but it ain't water.

Wish I could reverse the flow once in a while.

[spencer]

Let us get some facts straight before we go any further.
Bartlett claims, and TK agrees that the supply side is supposed to improve the long run growth rate of the economy. But look at the data. Despite all the claims about stagflation in the 1970s, there was no difference in real gdp growth between the 1980s and the 1970s. If growth was just as strong in the 1970s as it was in the 1980s how can the supplysiders claim that their policy increased the long run growth rate. This is especially true if you look at productivity growth which was smaller in the 1980s then in the 1970s.

The supply side argument is that if you use the federal deficit to shift resources to the investor class -- the wealthy -- this will lead to them increasing investments. But guess what, it never happened as we
are seeing this cycle. But over time the share of nonresidential investment done by individuals, s-corps, partnerships, etc that are subject to the individual tax code has fallen from and all time peak of about 25% in the 1950s to around 11% in recent years. Investment is done by corporations and individual tax cuts has little or no impact on corporate investment decisions. Supposedly a cut in the individual tax on dividends and capital gains leads to greater after tax returns that will lead to investors being willing to pay more for a stock so the market PE will rise and this lowers the cost of capital for corporations so they invest more. But again, there has been no change in the market PE because of this. There was a surge in the market PE in the 1990s but this was because of the irrational belief that long term corporate earnings growth has shifted higher. There is absolutely no evidence that individual tax cut on dividend income and capital gains has lead to a lower cost of capital for corporations.

If supplyside economics were working we would be seeing an increase in the potential long run growth rate of productivity and the economy. Despite the improvement in productivity in the 1990s and a return of productivity growth to similar growth rates as it had in the 1950-75 era there is little or no evidence that tax policy had a significant role in this improvement. Again the 1990s capital spending boom that improved productivity was driven almost completely by a plunge in the price of computing power,not changes in tax rates.

I'm still waiting for supplysiders to show me any evidence that their tax cuts have lead to an increase in the long run growth rate of the economy.

[Bruce Bartlett]

People need to keep in mind that this was not some purely theoretical debate taking place at some academic conference or in the pages of obscure journals. The people I was working with were members of Congress and their staffs and we were battling specific policies by putting forward specific policies of our own. Many people on both sides were unaware of the theoretical underpinnings because they were unstated, implicit. Part of the supply-side strategy was to make those assumptions explicit. I mention some of them in my article.

[robertdfeinman]

Step back and examine the (implicit) assumptions in these discussions.

1. Lowering the tax rate on various items will have an effect on behavior. This is imputed information. There is no evidence that lowering the estate tax causes people to save more. Or that lowering the capital gains tax increases investment.

2. The "goal" of both camps is growth. Growth is needed in a mature economy why?
There is natural growth from population increase, but aside from that most growth is sold as a way to help the poor. We've had growth for two hundred years and we still have the poor.

3. There are two opposite schools for monetary policy and neither can prove that their course of action has "worked". Yet they both maintain their model is correct. This is unscientific.

So we have unverifiable claims about human nature, the benefits of growth and the applicability of various theories. This is not science, it's faith-based policy making.

The real difference is one camp favors polices which help the rich and the other favors policies which don't hurt the poor. Then they find pseudo-scientific explanations for their ideological leanings. The key characteristic of science is that it is testable. Macro economics can not meet this criteria.

[real person from the real world]

I think one of the points Barlett makes is that an idea was hijacked. A simplistic slogan that was based on an economic concept that you may or may not agree about, was used over and over again, to justify the implementation of some very self serving policies by past Republican administrations, and those who had the bucks used it as their banner. What's been done is done, now is the time to fix the mess that has been created, except the wrong people (corporate America, and the supper wealthy) now have all the power to stymie any pragmatic reform that rocks their nice little boats.

says...

I'd have to agree that "supply side economics" is mostly an ideological term. Apart from Friedman, Modigliani, Vickrey, etc. how many supply-side economists support land rent taxation such as is imposed in Hong Kong, Taiwan, South Korea etc. and used to be levied in California (pre-Prop 13) and Japan?

[Bruce Webb]

I can live with this. Lets validate Bruce Bartlett's original work product, restore Reagan era top marginal rates and call it good. Somehow I suspect Mr. B wouldn't go along. But this is all good, it might even be right:

"As the staff economist for Representative Jack Kemp, a Republican of New York, I helped devise the tax plan he co-sponsored with Senator William Roth, a Delaware Republican. Kemp-Roth was intended to bring down the top statutory federal income tax rate to 50 percent from 70 percent and the bottom rate to 10 percent from 14 percent."

Heck I would be happy to take Clinton era 39% top rates. But since Bruce Bartlett is a lot smarter than me on this lets take it to 50%.

[Paul Krugman]

Bruce Bartlett says this:

"Among the beliefs held by the Keynesians of that era were these: budget deficits stimulate economic growth; the means by which the government raises revenue is essentially irrelevant economically; government spending and tax cuts affect the economy in exactly the same way through their impact on aggregate spending; personal savings is bad for economic growth; monetary policy is impotent; and inflation is caused by low unemployment, among other things."

Wow. You see, I was a grad student at MIT - the great Keynesian stronghold - in the 1970s, and this bears no resemblance to what was being taught.

In fact, I still have my copy of Dornbusch-Fischer, Macroeconomics, the 1978 edition - and it doesn't make any of those assertions. I'm particularly amazed by the "monetary policy is impotent" bit: no mainstream Keynesian in America believed that any time after, say, 1955. Dornbusch-Fischer is mainly *about* monetary policy, and how important it is.

Let me suggest that good economic doctrines don't have to be sold by misrepresenting what other doctrines say.

says...

Paul Krugman: Bartlett is probably confusing the opinion of policymakers and policy advisers with the opinion of mainstream economists. Mainstream economists clearly did not believe the things you mention, but many "policy entrepreneurs" certainly did. Then again, the misleading simplification of "supply side economics" doubtlessly is due to the same phenomenon.

[howard]

sheesh, i was all set to note what...paul krugman just posted! so let me simply say that while i respect bruce bartlett tremendously - a man who actually lost a position in a right-wing foundation for being honest! - i, like krugman, did not for a second recognize the version of keynesian thought that bartlett claims prevailed back then, when i was a mere economics undergrad.

but since krugman has said it so well, let me note that it's not impossible that (as bartlett comments upon at 6:25) there were people in congress who believed the version of lord keynes that bartlett is peddling here.

and let me also note that if bartlett's distortion of the '70s view of keynes is what it takes for him to march around denouncing today's tax-cuts-uber-alles morons in the gop, i'll live with it.

[Bruce Bartlett]

If Paul Krugman is right, then where did all the policy mistakes of the 1970s come from? Why did the Fed act as if the money supply had no linkage to inflation until Volcker changed gears in 1979? Why did the Congressional Budget Office routinely report that a tax rebate, a permanent tax rate reduction, and an increase in government purchases would have exactly the same macroeconomic effect because their only impact was on aggregate spending? I have some of those old reports in my library and can dig them out if necessary.

Of course, there were those in academia who knew better. Maybe Paul was one of them. But they weren't in charge of the Fed or the CBO. Also, I think a lot of economists who lived through the the 1970s and know better today have simply forgotten how screwy some of the economic policies of that time were and how many reputable economists supported them. Go back and read Leonard Silk's columns in the New York Times to see what mainstream economics was all about in those days. Don't go back now and cherry pick the isolated case where someone had it right. We had to do what we were doing in real time without the luxury of long and careful study of all the alternatives. It was a crisis atmosphere and we did the best we could with what we had to work with.

[Callahan]

My all time favorite is "voodoo economics".

[robertdfeinman]

Not to beat a dead horse, but how do you know that what Volcker did "worked". Coincidence doesn't prove causality.

The one thing that is true is that conservative economic fixes always provide money to the rich immediately while liberal ideas always involve long range plans which might help the poor eventually.

When someone gets a tax break they get the money, whether it has some vague impact on the overall economy is an open question. Meanwhile they have the cash.

The only program in the past several decades that was actually designed to help the poor in the present was the EITC and this was also, in effect, a deal for the rich. What it does in effect is let employers who underpay their workers shift the costs onto society at large rather than requiring them to pay a living wage. We see the same policies unfolding again with the move to shift retirement and health costs from employers to the public. I have no problem with socialized medicine and retirement, but where is the corresponding effort to make business pay its share?

The level that business pays for government has gone down steadily for decades. Instead of investing this money the higher profits have gone into bloated salaries for management and fiscally dubious takeovers and hedging schemes.

[calmo]

I see Bruce Bartlet and Paul Krugman have conflicting views about this instance of referential opacity: from Bruce

"The context in which the term had meaning no longer exists and therefore it has become a barrier to communication rather than a facilitator."

And from Paul:

"You see, I was a grad student at MIT - the great Keynesian stronghold - in the 1970s, and this bears no resemblance to what was being taught."

Ah, but we were only head strong in our youth and only thought we knew what we were being taught. But now in our later years (wise and wisened-up) we can now state unequivocally that the context in which the term had meaning had gone the way of the hair on my bald head.
It had real meaning then, just a tad effervescent.
Soon we will be somewhat past wisened-up and not be able to make this determination --poor eyesight maybe confusing your knee for your forehead...or worse --mistaking someone else's knee...they might not mind.

Huge advantage having a language that is written down and used as some anchor on these worries, no? Not that the anchor cannot drift a little, but then what exactly is the point of making these scratches in the tablet?

[DRR]

Seriously. I like all of you, but just this once I wanna hear the experts talk.

[Callahan]

Thanks DRR, but I believe I've said enough.

[Mark Thoma]

Thanks Paul - I was going to make the same point, particularly about monetary policy, but I ran out of steam. It was the attempt to use monetary policy (because they thought it worked) that led to the inflation problems of the 1970s. It's hard to argue that monetary policy was used incorrectly in the 1960s and that they didn't believe monetary policy had any effect at the same time.

Thanks Bruce for your comments as well. I thought you were saying something about the state of the profession today, not just in the 1970s, when you said "Today, hardly any economist believes what the Keynesians believed in the 1970s and most accept the basic ideas of supply-side economics." It was that characterization I was addressing.

[anne]

Mark Thoma:

"It was the attempt to use monetary policy (because they thought it worked) that led to the inflation problems of the 1970s."

It was the failure to use monetary policy that led to the inflation problems of the 1970s.

It was the failure to use monetary policy, possibly because they did not believe it would work, that led to the inflation problems of the 1970s.

[kevin quinn]

Mark,

I'd like to add one perspective to your very nice discussion of the NK and RBC alternatives. Both of these schools agree that macro-inefficiency stems solely from nominal price rigidity - they disagree on how important that is. For "coordination failure" Keynesians, on the other hand, there are multiple equilibria in the natural rate of output and they are Pareto-rankable, with the highest being preferred by all to any lower value. On this view, some of the fluctuation in the blue line can be seen as shifting from one to another equilibrium in the natural rate. This means that there is potentially a role for counter-cyclical policy even in a world with no nominal rigidities - the role of focusing the economy on the best of the multiple equilibria. I believe that this third group is truer to the spirit of Keynes than the NK view you describe - although this doesn't of course make them right!

[Blissex]

If Paul Krugman is right, then where did all the policy mistakes of the 1970s come from? Why did the Fed act as if the money supply had no linkage to inflation until Volcker changed gears in 1979?

They were not *mistakes*, they were deliberate policies designed to pursue political important goals. Keeping the voters happy during difficult times was deemed more important than price stability. Something similar has happened again recently:

http://www.dailymail.co.uk/pages/live/articles/news/news.html?in_article_id=443540&in_page_id=1770

The recent deliberate policy to create colossal asset (in the West) and cost-of-living (in Asia) price inflation via extraordinarily easy money has also been taken quite consciously for political reasons, just like the 1960-70s.

Also, I think a lot of economists who lived through the the 1970s and know better today have simply forgotten how screwy some of the economic policies of that time were and how many reputable economists supported them.

Well, a large part of that was excessive faith in the ability of markets and entrepreneurs to adapt to any conditions. Instead the one great legacy of ''supply side'' was to point out that government policy matters as to creating a suitable climate for business and growth, as the markets and entrepreneurs cannot be given for granted, they can't do their job under all conditions.

[anne]

What I remember was reading Lyndon Johnson as almost, well, actually threatening the Federal Reserve chair not to use monetary policy to slow the economy in the last 1960s.

[anne]

Somewhere in one of the major biographies of Lyndon Johnson, there is a description of him grabbing the Federal Reserve chair by the lapels and asking him whether he knew what it meant to be a patriot or some such threatening question. The result was the Fed did not use monetary policy to limit growth.

says...

Blissex: AFAICT, India is the only Asian nation that could be said to have excessive cost-of-living inflation. Japan is still deflating, and China has an extremely elastic labor supply which helps keep inflation down.

[Callahan]

I wonder. What would happen to the economy if:

1. Wimin stayed home and became housekeepers, mothers, and wives.

2. The stay at home wimin thing created a shortage of workers.

3. In stead of employers rushing to get H1 and illegal workers, they hired American men.

4. Due to the shortage of workers, employers had to pay a living wage.

5. With wimin at home, the crime rate dropped significantly.

6. With wimin at home, we lived in cleaner abodes.

7. With wimin at home, we were all much happier?

What would happen then?

says...

Due to the shortage of workers, employers had to pay a living wage.

Wrong. If wimyn were to become unproductive, the shortage of workers would translate into a shortage of consumers, so the wage level would drop significantly. You are positing a free lunch which doesn't exist.

[Callahan]

To says:

I like the wimin stays home thing anyway. Now you see the true Callahan.

[anne]

Me; I wonder at what a complete fool you are, and a nasty fool to boot.

[Callahan]

Anne, Shucks, I just wanted to stir up a little debate.

[save_the_rustbelt]

Excellent conversation until that gender deal at the end.

I do think Bruce is correct in that the framework for the debate has shifted significantly from the 70s, who gets credit or blame and how far the debate shifted is subject to, well more debate.

[anne]

Oh, then I suppose I understand. Actually, I wonder what the effect on growth would be in Japan were there more than token and temporary inclusion of women in the workplace.

[Callahan]

Guess we (society) are not yet ready for a return to the wimin at home thing.

Oh well, it was just a what if. Don't economists ever play what if?

[anne]

Also, I have never found any convincing account of the complex effects of increased inclusion of women in the workplace or, for that matter, of the effects of women leaving the workplace for a time after the World War.

Elizabeth Warren writes of 2 worker families, but not meaningfully for me.

[anne]

Beyond playing at reversing history, because the idea is foolish and mean, understanding the implications of women in the workplace is a huge topic that at least for me is little explored in meaningful ways.

[Callahan]

Guess I was just reflecting on what I call the good old days (the fifties). My mommy stayed home, and so did most other mothers that I knew back then. Least thats how I remember it.

No disrespect to Working Women meant here.

Just kidding around a bit with a wild what if.

Sorry if I've offended anyone.

[James Killus]

I would feel better about the statements on policy in the 1970s if I had seen two references. One is to the "$50 tax rebate," which got me into an argument with an economist at the company I worked for. I held that it was needlessly inflationary; he told me that I was ignoring the "social effects of unemployment."

The other thing is a name: Bert Lance, a small town banker who thought that small town easy money policies were just what a large country needed.

The oil shocks might have been mentioned more often as well, plus the dunderheaded policies, such as the "oil quotas" that happened because of them.

Which is to say that keeping the discussion confined to monetary and tax policy may be a bit narrow.

says...

I think Callahan's post was quite interesting actually, because the same kind of argument can be applied to wimyn, immigrants, offshore workers and emerging countries - all of them enlarge the economic "pie", even though American men might have to content themselves with a smaller share.

And if you want to make their slice larger (say, in order to discourage crime) it's more efficient to subsidize them directly, rather than trying to reverse the original change.

[howard]

Callahan, next time you're inclined to stir things up, you might want to remember that the '50s weren't all that swell.

meanwhile, back to the topic at hand: it would be interesting to go back and read what leonard silk was saying in the '70s, but i'm really puzzled about bruce bartlett's implied suggestion that supply-side thinking, as defined in real time in the '70s, brought an end to stagflation. as far as i can tell, it was the volcker-induced recession that brought an end to the "flation" part and the keynesian stimulus of tax cuts without spending cuts that ended the "stag" part.

plus what spencer said.

i mean, in the scheme of things, i think bartlett is onto something: the policy-making consensus of the mid'70s was finding stagflation hard to deal with, and the "supply siders" brought some new ideas to the table, many of which are, in various ways, part of our common discourse today.

but still, one would like to know what the actual policy/outcomes were: am i misremembering how things went back then?

[Callahan]

Howard, I have to disagree with your comment "the fifties weren't that swell" In 1956, my father earned $4.00 an hour. He was able to support three sons, and a stay at home wife. We lived in a new house, and he owned a new Ford. We went on vacations, and he was able to save a little bit.

My father was a skilled tradesman (tool and die).

I have what is supposed to be a good job today, and comparable to me fathers occupation. My real earnings compared to his though, just don't stack up.

So to me the fifties were fanfreakingtastic.

[howard]

callahan, i don't really want to divert this thread onto the '50s: i had a swell childhood myself then.

but on a national level, here's what was true about the '50s: de jure and de facto segregation ruled the land. there was tremendous cultural pressure for conformity, leading to all kinds of hidden problems with domestic violence and alcohol that were simply never spoken of. women, while somewhat subject to de jure restrictions on what they could and could not do, certainly faced enormous de facto restrictions. anti-semitism was still rife. homosexuality was completey in the closet. honest-to-goodness racists held the controlling votes in the senate. poverty and hunger were far more widespread in america than they are today.

one could go on, but the point is, don't confuse your happy childhood with the totality of the american experience of the '50s.

[Bruce Bartlett]

Inflation was indeed the central problem. But policymakers were repeatedly told that to bring it down to tolerable levels would require an economic contraction as long and as deep as the Great Depression. It was hard to argue that the benefits of ending inflation were greater than the negative effects of another Great Depression. So policymakers just kept monetary policy on automatic pilot until the spectre of hyperinflation emerged. At that point, every serious person knew that something had to be done. Where I credit supply-side economics is in making the transition from a high inflation environment to a low inflation environment as quick and painless as possible. Of course, the 1981-82 recession was painful, but it was less painful than the 1974-75 recession, which did little to even moderate inflation, and a lot less painful than the Great Depression. If we hadn't cut tax rates in 1981 and taken the other supply-side measures Reagan took, the transition would have been vastly longer and more painful, in my opinion.

[knzn]

Bruce Bartlett:

Why did the Fed act as if the money supply had no linkage to inflation until Volcker changed gears in 1979?

I don’t think the Fed did act this way. The standard monetarist explanation of inflation is “too much money chasing too few goods.” The difficulty is sorting out the “too much money” part from the “too few goods” part. The 70s faced a productivity slowdown, which at first was mistakenly thought to be temporary, as well as a constriction in the supply of oil. In an important sense, it was not so much a case of “too much money” but of “too few goods,” and the Fed, being uncertain, was slow to adjust the money supply in response.

Also, as Blissex has suggested, I think you misattribute political factors to economic beliefs. Everyone at the Fed knew that monetary policy could stop inflation, but the question was: at what cost? And who takes the heat? Volcker differed from his predecessors not in his economic beliefs but in his willingness both to make the country suffer the necessary consequences (which, as you may recall, were rather unpleasant) and to take the political heat personally. As Volcker later acknowledged, the real purpose of the monetary-aggregate targeting was to provide political cover for a policy that was otherwise quite consistent with Keynesian economics.

And on a separate note, I think a strong case can be made that tax cuts such as the Kemp-Roth cut have exactly the opposite of the intended supply-side effect. Reducing marginal rates, in and of itself, has a beneficial supply-side effect, but reducing taxes overall (as rate reductions generally do) has a detrimental supply-side effect, because it increases disposable incomes and thereby increases the demand on resources by consumers, leaving fewer resources available for growth-enhancing investment – the “crowding out” effect. The US was (and has been) able to reduce crowding out by importing resources from abroad, but even so, the net crowding-out effect may well have exceeded the beneficial incentive effect. Certainly we did not see personal saving increase as a result of lower taxes.

[Callahan]

Howard, for working men in the fifties, it was a much better economy then than it is today. Now I'm not talking about civil rights and the like. An idiot knows that such issues are much improved today, but the economy, that's the economy has not improved, in fact is much worse, unless you are among the very rich.

says...

Callahan, the interesting point is that your father was forced to support his wife, so his effective earnings were quite a bit lower than that. Stay-at-home wives are still around, but they do have to make some tradeoffs.

Blue-collar employment has certainly declined compared to the 1950s, but the flip side of that is the significant rise of skilled white-collar jobs.

[howard]

callahan, i suppose what you mean is: "during the 1950s, the traditional nuclear family fit well with the demands of the leading industries of the day, which were primarily manufacturing in nature and had lots of well-paying jobs thanks to strong unions which enabled a single breadwinner to support said nuclear family."

with which i can't disagree.

but next time, why doncha just say that instead of making some broad untrue generalizations about the '50s (and if you think that all men had an equal shot at those good jobs, you're sadly mistaken).

bruce, thanks for your clarification at 10:36, which i do think is a reasonable read on the situation, although of course we don't have a test-tube that would allow us to compare the recovery from the volcker-induced recession under carter-era tax rates as compared to reagan-era tax rates.

and now i'll let the real economists, like knzn, continue on and try to learn something.

[Callahan]

Says: This is my last comment on the subject. I have one of those so-called skilled white collar jobs, I'm an IT programmer. But my real earnings do not even come close to that of my father. There is nothing anyone can say that changes that fact.

If I had two such jobs (programmer) then I would be getting into a category with real earnings greater than that of my father.

I rest my case.

[knzn]

By most measures, the 1981-82 recession was more painful than the 1974-75 recession, and in fact the latter did moderate inflation, as you can see if you look at the inflation series in the 1975-77 period. The problem was that the Fed pushed the recovery too hard. What Volcker was willing to do, specifically, was to keep the 1981-82 recession going for as long as necessary to get inflation down to an even lower level and then to be very cautious about pushing the recovery. I strongly disagree with the opinion that cutting tax rates prevented the transition from being more painful. Volcker’s credibility helped, but the tax cuts meant that interest rates had to be higher for longer and that traded goods industries suffered long-term damage due to a strong dollar.

[knzn]

Also, I don’t know who was saying that brining inflation down “would require an economic contraction as long and as deep as the Great Depression.” It’s true that conventional Keynesian estimates of the sacrifice ratio were higher than what it turned out to be, but not so dramatically higher. I think you would have a very hard time finding any actual economist of the time who came up with a quantitative estimate of the required contraction that came anywhere near the severity of the Great Depression.

[Blissex]

If we hadn't cut tax rates in 1981 and taken the other supply-side measures Reagan took, the transition would have been vastly longer and more painful, in my opinion.

As to that I quite agree -- in part because it is sensible, standard Keynes-style fiscal policy ;-), in part because the level of taxation had reached ridiculous levels.

Note however that as remarked long ago, "ridiculous" above does not necessarily mean "damaging", as top tax rates were very high in the fifties too, a golden era. The case against excessively high taxes is mostly moral (confiscation), rather than economic, while the case against excessively low ones is economic (a business and growth friendly infrastructure is expensive) as well as moral.

Howard, for working men in the fifties, it was a much better economy then than it is today. Now I'm not talking about civil rights and the like.

Well, that was in part because of politics. Working white men were the pillars of USA conservativism (and they still are, inasmuch they are asset and gun owners), and the inflation of the late 60s and the 70s was in part designed to buy them off; the buying off was in part meant to conserve their support for the war, in part to keep them happy even if blacks and women were given civil rights, in part to detach their interests from those of students and other ''subversive'' elements (the latter especially in Europe).

AFAICT, India is the only Asian nation that could be said to have excessive cost-of-living inflation. Japan is still deflating, and China has an extremely elastic labor supply which helps keep inflation down.

Well, Japan is an old economy, and I should have added ''developing economies of'' to "Asia". However China has a very, very high rate of cost-of-living inflation. It is very uneven though: the price of essentials is going up very fast, the price of manufactured consumer goods is going down. Those on a fixed income are, as always with high inflation, suffering a lot: sure they can now buy much cheaper cars and stereos and computers, but things like housing, health care and even food have become far, far more expensive.

The same is happening in all countries in Asia where the wall of money from Japan and the USA and Europe is flooding in.

[dale]

Anne, would you unpack this statement of yours: "Elizabeth Warren writes of 2 worker families, but not meaningfully for me."

What do you mean by "not meaningfully for me."

[calmo]

We have 2 first hand (and DRR would say first rate too, but I hesitate, just knowing this would back-fire if I said it), but different accounts of what happened, howard.
We can shelve our sensitive memories and defer to what DRR refers to as experts (until Callahan squashes that but good) who are busy reviewing the historical accounts (seeing as how their memories reached only stalemate and not the resounding triumph usually reserved for experts).
This used to be a topic in philosophy (hello eva) that worried about whether the item denoted by, say, "Platonic Dualism" (the idea not the sword fight) ["supply side economics"] meant the same thing it did then as it does now. Of course I did not go very far in philosophy (either) and just know this problem was solved or dismantled, not shelved.
I think it works something like this: the competing or at least apparently differing views get aired and that meaning does change. We, holders of that meaning, (interested parties) benefit from the dispersion of opinion...even from Callahan...ok, and having Bartlett and Krugman exercise themselves here is first rate (if DRR will allow me that much).

[Blissex]

wimyn, immigrants, offshore workers and emerging countries - all of them enlarge the economic "pie", even though American men might have to content themselves with a smaller share.

Not quite: the share of suburban, white, asset owning, middle aged, native citizen «American men» has grown significantly.

These are also by and large those who vote and most importantly those who donate to political campaigns.

The extraordinary expansion in the american and globally traded labor supply has been only of benefit to the largely ''rentier'' category above.

Woe to those american men who do not fit the profile above, they now hve to compete with a lot more claimants.

[Callahan]

Being mentioned by some of you here (lofty as you are) inflates my ego some, maybe even enough to make me think that somehow, in my own crude way, I've contributed to the debate.

Again sorry if the "wimin" thing offended anyone.

Working American Women are great, it's just too bad that it takes two incomes to make a "decent" living today.

That's it.

[knzn]

Blissex, how is a tax cut “sensible, standard Keynes-style fiscal policy” in a time when you’re trying to reduce inflation? I grant you that the tax cuts helped get us out of the recession, but monetary policy could have done so just as easily in the absence of the tax cuts; there was plenty of room to cut interest rates. If anything, the tax cut made the transition worse by making it more difficult to maintain Fed credibility. Indeed, some people were arguing at the time that tight fiscal policy is necessary to reduce inflation because the Fed would ultimately be forced to monetize the burgeoning debt. (Obviously they were wrong, but the fact that they were making the argument indicates that the tax cut was harming Fed credibility.)

[Bruce Bartlett]

In an article in the American Economic Review (May 1978), Arthur Okun said that to reduce the basic inflation rate by 0.3% would require raising the basic unemployment rate by one percentage point for one year. With inflation well into double digits by 1980, one can see that it would indeed require unemployment on the scale of the Great Depression to bring inflation down to a tolerable level.

[jayackoryd]

"If Paul Krugman is right, then where did all the policy mistakes of the 1970s come from?"

Nixon's and the Fed's attempts to prevent, through money illusion, a recession caused by Arab oil embargo following the deficits run to finance the Vietnam war.

That did offer a laboratory test for the the New Classicist claim that, as Sargent restates the Lucas critque, people aren't stupid--that money illusion doesn't work for long--is supported by that experience.

But Krugman is right when he says that Bartlett's description is something of a caricature. OTOH, Laffer apparently really did draw the thing up on a bar napkin.

[Blissex]

tax cut “sensible, standard Keynes-style fiscal policy” in a time when you’re trying to reduce inflation? I grant you that the tax cuts helped get us out of the recession, but monetary policy could have done so just as easily in the absence of the tax cuts; there was plenty of room to cut interest rates.

Well, there is that ancient legend :-) that one cannot achieve two policy goals with just one policy tool (in the general case).

If the goal was to kill inflation but to reduce the impact on output, then using high interest rates (monetary tightening) with lower taxes (fiscal loosening) was at least a plausible combination, and sort of standard Keynesian (as cutting taxes did not quite correspond to a cut in spending).

Of course one designed to favour asset owners rather than workers, especially as Reagan cuts involved cutting capital gains taxes to well below income taxes, a crazy distortion that the USA are still paying for dearly.

[knzn]

From the Keynesian point of view, the way to use the two policy tools was to raise taxes (or cut spending) dramatically while making relatively more restrained use of monetary tightening. That way you minimize crowding out and allow investment to increase the long-run growth rate.

[knzn]

Using Okun’s coefficient, a 7% NAIRU estimate (clearly higher than what most economists estimated during the 70s), and the unemployment rate series from 1933 through 1939, I get a reduction of inflation by 25 percentage points. We only needed to get from 10% to 4%. The Great Depression was more than we needed by a factor of 4.

[JD]

Ah, Bartlett plays the "no one knew any better way back then" card. Too bad Krugman shows that plenty of people did know better. BB was a sophisticated enough guy back then; why should he get off the hook because behind-the-times folks at the Fed, the CBO, or the NYT genuinely didn't know better? Unless there's some special reason otherwise, you should be judged against the smartest folks at the time, since that could have been you if you had been honest and worked at it. Citing MIT isn't cherry-picking.

[Donald A. Coffin]

callahan argues that the 1950s were some sort of living paradise, because his father was able to support a family on an hourly wage of $4. That's more than double the nominal average annual earnings in 1955 (which were about $1.75), and would be equivalent to more than $29 per hour today. So, yeah, that could support a nice middle-class life--then and now. Even not accounting for productivity growth.

[Paul Krugman]

A late entry - I'm on the road.

Anyway, Bruce Bartlett's contention that the inflation of the 70s happened because people didn't think money mattered is just bizarre. There was a way too expansionary monetary policy in 1972, not because people didn't think it mattered, but because they did: it's widely believed that Arthur Burns pumped up the economy in an attempt to help Nixon win the election. Nixon's people worried about the effects of monetary policy all the time!

We might also want to mention two horrific oil shocks.

Again, what Bruce is describing is a caricature of an vulgar ultra-Keynesian, circa 1947. People like that never dominated Keynesian thought in the United States, and were pretty much nonexistent by the time supply-side economics came into existence. And no, it's not a matter of policy entrepreneurs versus academics: look at the people who were actually advising Gerald Ford or Jimmy Carter on economic policy, and they were nothing like the caricature Bruce describes.

It's sad, really: to make supply-side economics look respectable, it's apparently necessary to pretend that everyone else was an idiot.

[Don]

I think Callahan's post was quite interesting actually, because the same kind of argument can be applied to wimyn, immigrants, offshore workers and emerging countries - all of them enlarge the economic "pie", even though American men might have to content themselves with a smaller share.

A lot of the "extra pie" has been taken by capital rather than labor, so for the median or below median worker their "slice" may not be as large as it was before. If I get a smaller slice on my plate do I really care how big the pie it came from is?

[ken melvin]

In the 70's Nixon brought in Milton Friedman, things got worse, Nixon got rid of Milton and said, 'I am now a Keynesian'.

[bakho]

Can "supply-side" tax cuts (basically fiscal policy) be a useful way to model policy effects as a stand alone (basically ignoring monetary policy)? The only way for supply-side tax cuts to have any effect on long term growth is if the fiscal policy of revenue collection is so extreme that it inhibits effective monetary policy. In such a case, tax cuts would be a useful corrective. Is there a shred of evidence that tax policy in the US was so extreme that a corrective reduction on taxes paid by the wealthy was necessary? We have already seen the other extreme where so little fiscal spending was added during the 2001 recession that we were discussing the liquidity trap and monetary policy sent interest rates to near zero.

Presumably, fiscal and monetary policy work in conjunction to produce the optimal rate of growth. Under these conditions, changes in fiscal policy (that would expand or contract the economy) are balanced by monetary policy to keep the growth rate from being inflationary or producing excess unemployment. Under these conditions, there is little linkage between supply-side tax cuts or fiscal policy and growth rate. Monetary policy will always be altered as a corrective measure.

So called supply-side tax cuts are proposed as a corrective to fiscal policy that collects too much revenue. The other extreme is a fiscal policy that collects too little revenue and as a result underinvests in infrastructure. One result of supply side tax cuts is to shift tax burden from the wealthy who benefit the most from government services to the middle class and poor. Another result of the supply side tax cuts is to starve the government of revenue that is needed to provide the infrastructure necessary for productivity increases and growth. In this environment, services for wealthy special interests are supported while services for disorganized interests of the middle class and poor are cut. There is zero evidence that supply side tax cuts have had any effect at all on long term growth rates. There is a lot of evidence of ever larger increases in inequality after cutting taxes on the wealthy. There is a lot of evidence that investments in our infrastructure are being shortchanged in ways that will diminish future productivity.

[Bruce Bartlett]

I think Paul's memory is just wrong. Has he forgotten how intense the arguments were about monetarism? A lot of people thought Milton Friedman's monetary ideas were crazy. And while it's true that Arthur Burns did a horrible job as Fed chairman, he inherited a situation in which inflation was already a serious problem. Jimmy Carter clearly had no clue about it and appointed G. William Miller as Fed chairman who gave us double digit inflation. I remember him testifying before the JEC that inflation was caused by failure of the anchovy harvest. I'm not making this up. They are used in fertilizer, which raised the cost of farming, which raised the cost of food and so on. Maybe up at MIT, people had it all figured out. But down in Washington, where I was, a lot of important people were seriously clueless.

says...

If I get a smaller slice on my plate do I really care how big the pie it came from is?.

Of course not. But if losers want to be compensated for their loss, they should ask for such compensation rather than insist that the overall pie hasn't got bigger.

When women entered the labor market, male workers were compensated for their wage loss, since they no longer had to support their now working wives. The same principle can work elsewhere.

[John Merryman]

Some radical ideas of mine,

For one thing, debt is a form of investment that is necessary to support the value of the money in the first place. Consider that the government increases the size the money supply by buying its own debt and decreases it by selling debt. So the effect of the enormous amounts of deficit spending by the government is to soak up what would otherwise be surplus savings. It amounts to a temporary nationalization of surplus wealth. Why not permanently nationalize more of it through higher taxes?

On this note, it is believed that inflation was brought under control with higher interest rates, yet this also served to deepen the recession and thus reduce the demand for money. How do you cure an oversupply when you also reduce demand? The government actually reduced the size of the money supply the way it always does, by selling debt. Remember that by 1982, deficit spending was reaching 200 billion a year.

In 1996, Bob Dole's campaign slogan was, "We want you to keep more of your money in your pocket." My first thought was, 'Thank God, it's not my money, or it would be worthless.
As I thought about it, the logic of this came to me; Money is actually a form of public commons! It is just like the public road system. While you may own the value of the money, just like you possess the section of road you are on, its usefulness is in its connectivity with what everyone else has and the actual mechanism, the monetary system, is public property. Even billionaires can't drive down the road at 110 miles and hour and expect everyone else to get out of the way, yet that's how the economy is run. The problem with treating the economy like a game of Monopoly is that in Monopoly, when one person controls everything, the game's over and you start again. In real life, this stage is usually referred to as revolution and involves pitchforks and torches. This isn't a socialization of money, it's how it really works to begin with. We just have to start thinking of it in these terms. In fact, if people started thinking of money as a form of public property, they may not be as obsessed with holding as much as possible and may start investing in their society and the environment more.

[anon]

I think Bruce Bartlett's invocation of Miltion Friedman to discredit Keynesian monetarism is just wrong. The orginal, and extreme, version of Friedman's monetarism was the all you had to do to stabilize the economy was keep some aggregate monetary measure of choice (I think M2) on a steady growth path consistent with your best estimate of the full employment equilibrium GDP growth rate. You can be a Keynesian who believes money is important without buying that extreme version of monetarism (which Friedman himself eventually abandoned).

Krugman is correcta bout the bogusness of the claim that policy wonks were pedaling extreme simple minded fiscal Keynesianism that did not match what the academic pooh-bahs were saying. JFK's policy wonks did lots of analysis for his tax cuts, LBJs economic policy wonks warned him about the inflationary dangers of his fiscal guns and butter policies, but LBJ blew them off.

[robertdfeinman]

So we are to trust the Fed to do the right thing when a) the leading economists can't agree on what was done in the past, b) can't agree whether it made things better or worse and c) can't agree which theory should be followed in the future.

Would you use a doctor who said: "I don't know if this medicine worked in the past, people disagree on whether giving it made people better or worse, and I don't have any idea of what it does - trust me"?

Does the battle between the Big Endians and the Little Endians ring a bell?

Just to make the confusion complete the Fed is mandated to do to things which are in conflict with each other, increase employment and fight inflation.

[knzn]

“A lot of people thought Milton Friedman's monetary ideas were crazy,” and indeed they were. The idea that there was a reliable relationship between money growth and nominal income, this is an idea that actually became rather popular in the late 70s, and it turned out to be crazier than anyone realized, once Paul Volcker did his experimental test. There was some controversy about the idea that monetary policy could be used effectively to stimulate the economy (“pushing on a string”), but there was no controversy about the idea that monetary policy could be used to control inflation, if one had the will to do so.

[duncan cameron]

Domestic inflationary pressures in the U.S. were certainly considerable by the early 1970s. Most of the CPI rate increases can be explained by Keynesian demand-pull arguments; guns plus butter were straining capacity, with sticky prices. But, the 1968 gold market crisis, and the expansion of the Euro dollar market in the lead up to the first oil price hike in 1973 from $3 to $12 per barrel complicate the story.
American balance of payments deficits and uncontrolled expansion of Euro-dollar lending killed fixed exchange rates. From that point on, as currencies appreciated, domestic import prices did not go down in strong currency countries, but they certainly went up in weak currency countries. Quantity adjustment rather than price adjustment was the order of the day, introducing stagnation.
Monetary policy had uneven effects, as giant corporations could avoid high interest rate jurisdictions, but regular borrower could not.
The U.S. faced no balance of payments constraint once it abrogated its commitment to exchange gold for dollars held abroad by monetary authorities. It exported inflation.
World wide, the oil price hikes reduced demand, while oligopoly pricing raised the price level, hence stagflation.
The main story for economists was the application of open economy macroeconomics (Mundel-Fleming) to the U.S., and the demise of closed economy Keynesian models.
Supply-side economics was a clever political intervention designed to change the rules of who get what.

Movie Guy says...

A financial historical context:

The 1970s

Presidents of the United States of America
..Richard Nixon (1969-1974)
..Gerald Ford (1974-1977)
..Jimmy Carter (1977-1981)

Rapidly rising oil prices create an inflationary spiral, which raises interest rates. Recession follows. The expensive Vietnam War ends.

Outstanding debt from less-developed countries increases from $29 billion to $327 billion during the decade.

1970

The Economic Stabilization Act of 1970 (84 Stat. 799) served as a primary vehicle for President Nixon's subsequent economic actions in August 1971.

Automated Clearing House Interbank Payment System, a private company, is created to clear checks.

Congress charters the Federal Home Loan Mortgage Association (Freddie Mac) to provide capital to finance U.S. housing.

Bank Holding Company Amendments (BHCA) of 1970 - The BHCA of 1956 left a large loophole with respect to non-bank activities. Growing political concern about the growth of conglomerate enterprises lead to these amendments.

The Bank Holding Company Amendments (BHCA) of 1970 required Federal Reserve Board approval for the establishment of a bank holding company and liberalized non-bank activity restrictions.

1971

President Nixon preempted Bonanza, the Ponderosa, and the Cartwrights on Sunday night, August 15th, 1971:

President Richard Nixon announces his "New Economic Policy" in an attempt to revive the economy and control inflation. This policy is a major shift from traditional economic policies. To increase demand for U.S. goods in foreign markets, President Nixon devalues the dollar and ends the gold convertibility of the dollar. This devaluation allows the dollar’s price to float on world markets.

President Nixon imposes wage and price controls. He presents Congress with legislation to repeal tax on cars, to provide tax credits for business investments, and to reduce individual income tax.

Excerpt from 'The Commanding Heights' by Daniel Yergin and Joseph Stanislaw

'The Commanding Heights' excerpt is a worthy, insightful read.

Address to the Nation Outlining a New Economic Policy: "The Challenge of Peace"
President Richard Nixon
Sunday, August 15, 1971
9 PM Eastern, Oval Office, White House

If you have never read Nixon's Ponderosa address to the Nation, it sets the stage for understanding much of what was occurring. I also recommend reading the excerpt from 'The Commanding Heights'.

Executive Order 11615 - Providing for Stabilization of Prices, Rents, Wages, and Salaries
President Richard Nixon
Sunday, August 15th, 1971

Presidential Proclamation 4074 - "Imposition of Supplemental Duty for Balance of Payments Purposes"
President Richard Nixon
August 17, 1971

Address to the Congress on Stabilization of the Economy
President Richard Nixon
September 9, 1971

Address to the Nation on the Post-Freeze Economic Stabilization Program: "The Continuing Fight Against Inflation"
President Richard Nixon
October 7, 1971

1972

Inflation increases when President Richard Nixon lifts wage-and-price controls.

1973

The 1973 Middle East War occurs. Organization of Petroleum Exporting Countries (OPEC) increases oil prices, decreases oil production, and imposes an oil embargo on the U.S. that generates even higher inflation and a trade deficit.

1974

The oil embargo triggers the 1974-1975 world recession, which exacerbates the less-developed countries' debt burden.

The FDIC deposit insurance limit increases from $20,000 to $40,000 because of inflation.

1975

The Congress holds hearings and expresses concern about the concentration of Third World loans and the threat to the capital position of banks.

Eight of the largest U.S. banks are owed $37 billion. The largest portion of Latin American debt originates from U.S. banks, accounting for 217 percent of total capital and reserves.

Maine becomes the first state to allow the entry of out-of-state bank holding companies.

New York City is on the verge of bankruptcy and asks the federal government for a bailout. President Gerald R. Ford originally refuses, but he changes his mind after the city raises city taxes and cuts programs. The city obtains $2.3 billion in short-term loans from the government.

Home Mortgage Disclosure Act of 1975 (HMDA) - This act encouraged banks and S&Ls to lend mortgage money in low-income areas and required banks and S&Ls to document their lending practices.

1976

First National City Bank changes its name to Citibank.

Several banks license VISA.

1977

Inflation accelerates when President Jimmy Carter places emphasis on restoring economic growth instead of controlling inflation.

Community Reinvestment Act (CRA) of 1977 - This act directed banks and S&Ls