In the last installment of the series looking back at theory and policy of the late 1970s and early 1980s by those who were there, "Jamie Galbraith speaks for the 'vulgar Keynesians'". In the latest contributions, Bruce Bartlett responds to Jamie, and Jamie provides additional comments:
Bruce Bartlett: As always, I find Jamie's observations illuminating. I would just make a couple of points. First, it is unfair to take the actual operations of a government as being a coherent representation of any economic philosophy. If I were to use every action taken by the Roosevelt Administration to refute Keynes, that would be just as unfair as what Jamie has done in using Reagan's actions as the sole basis for judging supply-side economics.
Second, I think he conveniently leaves out an important part of the story as far as the JEC [Joint Economic Committee] was concerned. Before he and I joined the staff, the committee had endorsed a version of supply-side economics. The chairman, Senator Lloyd Bentsen, got every member of the committee to sign a report to that effect in 1980. So Jamie's actions were as much a counterrevolt against the position that had been adopted by the committee's Democrats as it was in opposition to what we on the Republican side were doing.
Third, by starting his commentary with 1981, Jamie goes well past the point I was trying to make in my New York Times article. I was writing about what motivated people to even think of supply-side economics in the first place, not about its operational consequences during the Reagan years. My focus was on the 1976-1980 period, when a small handfull of people were trying as best they could to grapple with an economic crisis caused by rising inflation. Just as with Keynesian economics, those who later became advocates for supply-side economics carried the arguments, the policies and the rationale off in a different direction. That was the whole point of my article. What Jamie really shows is that the bastardization of supply-side economics began much earlier than this administration, and he's certainly right about that.
Finally, if I were in Jamie's shoes, I would also be trying to make Jude Wanniski the focus of the discussion. Jude was a brilliant man, but also more than a little crazy. A much more important figure and one much more difficult to attack was Norman Ture, which is why people like Jamie tend to ignore him. But Norman was absolutely critical, not just because he was one of the leading tax economists in the U.S., but because his involvement with tax policy went well back into the 1950s.
Just as an aside, I would note that Norman had been on the JEC staff in the 1960s, where he functioned as staff economist for Wilbur Mills while he was chairman of the House Ways & Means Committee. It was Mills who really got Kennedy to propose a cut in marginal tax rates in 1963, based on Ture's ideas. Since Norman was also deeply involved in the development of the Kemp-Roth bill, he was a bridge to both major tax-cutting episodes. To the curious, I would recommend Julian Zelizer's book, "Taxing America," on both Mills and Ture.
Next, James Galbraith responds:
James Galbraith: Bruce [Bartlett] in his first response concedes my basic point: Reaganomics was incoherent. We crude and vulgar Keynesians knew this at the time.
So did Murray Weidenbaum. I saw Murray frequently in those days, at hearings, social events and at meetings of the U.S. Gold Commission, a gold bug endeavor foisted on the public by Jesse Helms and treated by nearly all the participants, Democrat and Republican alike, with amused contempt.
At one such meeting, fittingly held in the Cash Room of the U.S. Treasury, in early February of 1982, Murray came up to me with a sly smile on his face.
"Did you see Leonard Silk in today's Times?" I had not.
"Well, Leonard wrote about our Economic Report. He said there was plonking in it? Do you know what plonking is?" I did not.
"Well according to Leonard, there is Plonking, Type One: 'A little wild-eyed obfuscation' -- and then he quoted something that Bill Niskanen wrote." Niskanen was the CEA's resident libertarian.
"And then Leonard said there is Plonking, Type Two: 'The stupefaction of the blindingly clear' -- and then he quoted something Jerry Jordan wrote." Jordan was the house monetarist.
"And then," Murray concluded, "Leonard said there was actually something sensible in our Report, and he quoted something I wrote."
My comments were aimed at the incoherence of Reaganomics as public policy; it was my job, then, as a policy economist to make this argument. It did not matter to me whether or not the individual pieces of the Reaganaut argument were defensible. The fact that they were at war with each other was sufficient to make the combination into bad policy.
I opposed monetarism, then and since, on the ground that the Federal Reserve could not effectively treat the money supply as a control variable, without wrecking economic growth. I believe Bruce and I agreed on this point. We were, of course, vindicated (unhappily) by the recession of 1981-2, and by the statistical and intellectual collapse of monetarism in the following years.
As for supply-side economics, Bruce is right to note that I was part of a counter-rebellion against the bipartisan consensus in its favor at the JEC in the late 1970s, when I was dividing my time between the Banking Committee and graduate school, and largely engaged on other matters. I disputed supply-side economics, then as now, on the ground that the substitution effects of tax changes were unimportant compared to the income effects.
The supply-siders seemed to pretend that income effects did not exist.
We, of course, thought that the claims made for the substitution effects were grossly overstated. Henry Reuss and I did not expect tax rate cuts to produce significant increases in saving, investment or work effort. (And, of course, none occurred.) We did oppose the upward redistribution of after-tax income that the supply-siders were pushing for. And we did suspect that this was the true impetus behind their program. When Reuss became chair and I arrived at the JEC in 1981, these arguments began to be heard in JEC work.
But, in our minds, the greater danger from the supply-siders came from the blowback of their efforts on the other side of the budget. The supply-side agenda threatened to open up large budget deficits, and in 1981 those of us whose models (accurately) predicted that result feared that the consequence would be even more crushing cuts in social programs.
Events proved out somewhat differently. We got the tax cuts, but (as David Stockman discovered to his chagrin) the Republican votes for all the spending cuts the far right wanted were not there. Social Security, notably, survived. And when the recession hit, supply-siders and Keynesians were in approximate alliance on the key issue, which was first and foremost to force the Federal Reserve to bring interest rates down.
Later on, supply-siders and vulgar Keynesians were in the minority in both parties in being skeptical of the need to make deficit reduction the principal priority of fiscal policy. However, we continued to take opposite positions on what fiscal policy should actually do.
The major joint impact of monetarism and tax cuts in 1981-83 was, I think, not fully anticipated by either side. It was the rapid appreciation of the dollar, increased trade deficit, and financial globalization. (I began to write about this in my 1989 book, Balancing Acts). The effect was the early and *permanent* elimination of domestically-generated inflation from the system.
An interesting feature of our current discourse is, of course, that twenty-five years later mainstream monetary macroeconomics has still not figured out what happened. We still hear the voices who credit the vigilance of the Federal Reserve, its "credibility" "commitment" and so forth with keeping the economy from slipping back into excessive inflation. This, despite the plain evidence of the late 1990s, that even at full employment there is no inflationary risk.
It will be very interesting to see how long it takes (if it ever happens) for reality to penetrate this particular redoubt of academic and policy thinking. Of course, when it does, the proper role of the Federal Reserve will have to be very carefully re-examined.
Update: Follow-up from comments:
Bruce Bartlett: The great thing about Jamie is that he never hides his underlying assumptions or pretends that economics is a purely scientific endeavor, with no philosophical core. What he has brought out in this post is that much of the debate in the 1970s and 1980s over the proper role of monetary or fiscal policy was really about the proper role of government. Supporters of supply-side economics favored smaller government on both economic and philosophical grounds. We thought it would leader to a larger economy and more freedom. Keynesians like Jamie were not concerned about the size of government and saw no inherent loss of freedom from its expansion. Nor did they share the belief that there was any trade-off between equity and efficiency. The whole economic question could really be reduced to a simple one from their point of view: there were two equally effective paths to growth and prosperity; one that enriched the wealthy and screwed the poor and was therefore immoral; and another that was compassionate to the poor and viewed the wealthy essentially as rentiers who could be taxed heavily at no economic cost and was therefore moral. Clearly, those of a liberal persuasion would be attracted to the second approach even if they knew nothing whatsoever about economics.
The supply-siders felt that it was irresponsible and demagogic for the liberal Keynesians to make the promises that they were making because they could not deliver on them. The result of their policies were inflation and slow growth that would eventually impoverish the poor. The wealthy would be largely unaffected because they would simply move away or find other ways to enjoy their wealth in ways that the tax man could not get at. I remember Paul Craig Roberts pointing out that the reason Rolls Royces were so prevalent in England during the time that its tax rates were confiscatory was that the pleasure of driving the world's best automobile was a form of income that was not taxed. The supply-siders thought it would be better for such people to start businesses and buy stocks and bonds instead of expensive autos, because then some of the benefits would flow to society and not just to themselves.
There is another point about the supply-siders that I think Jamie is genuinely unaware of. Unlike conventional conservatives, the supply-siders never made a fetish out of cutting government spending. The original supply-siders thought that if we could simply hold the line on spending while raising the GDP growth rate, then spending as a share of the economy would fall painlessly. They also believed that many of the demands on government to supply income, jobs and social services were a function of slow growth. Therefore, raising the growth rate of the economy would both reduce the relative size of government and aid those at the bottom of society more effectively than government could do through direct action.
The events of the last 30 years have not resolved the question of which approach is better. In our own minds, Jamie and I know which is best and that we are not going to change each other's mind on the matter. We also accept each other's sincerity and that we aren't arguing our alternative approaches simply out of self-interest. That's why we can be friends despite our differences. But in the course of day-to-day debate in Washington, people don't have time to lay out their philosophy and operating assumptions. These things tend to get reduced to sound bites. Moreover, the longer a particular economic approach has been operational, the more likely that those in power are long removed from the original circumstances and analysis that it is based on. Thus the Keynesians of the 1960s had really lost touch with Keynes himself and were pursuing policies that were appropriate in the conditions of the 1930s, but not the 1960s. Likewise, I think that some of the policies being pursued under the guise of supply-side economics today cannot be justified on the same basis today that they were in the 1970s. That's what I was trying to say in my original article.
This disconnect is inherent in the nature of public policy and leads to cycles. The liberal Keynesian cycle lasted 30-some years from the 1930s to the 1960s. The conservative supply-side view also last about 30 years from the mid-1970s to the present. Both were successful initially because they offered solutions to real problems that could be embodied in specific policies that Congress could enact and which appealed to the philosophical and political interests of one of the major parties. They both ended when the problems they were initially created to deal with were essentially solved and when the advocates of their position lost touch with the fundamental truths of their position. Increasing, their advocates' arguments became caricatures of those that were made originally, became increasingly incoherent, and less able to deal with new problems as they arose over time.
Therefore, the real question is what comes next? I don't think Jamie's vulgar Keynesianism is going to be making a comeback unless the economy plunges into another depression. And I have no idea what will replace supply-side economics on my side. I can only assume that we are in for a period in which the right and left will be searching for new ideas and new gurus. That's not a bad thing.
James Galbraith: I think I did eventually figure out the supply-side position on government spending, but it's quite true that it wasn't clear to me in early 1981.
The effects of tax rate changes were being debated at that time in terms that were truly "crude and vulgar," but the topic is worth exploring a bit more.
The Keynesian position on the effect of marginal tax rate changes on saving was partly skepticism about a substitution effect, but not only that. It stemmed also from Keynes's argument that saving was a residual of the consumption decision and the determination of income. Therefore, saving was not something that should be treated as an independent decision variable of the household.
Similarly, employment is determined via the aggregate demand for output, itself a function of expected profitability and investment. For this reason, a thoroughgoing Keynesian could not accept that changing the post-tax reward to work effort would change effective effort or output.
These were key supply-side arguments at the time and key points of difference.
But the supply-siders have over the years emphasized other aspects of the effect of marginal tax rate changes as well, and much of today's discussion turns on these somewhat more subtle questions, namely income reporting and expenditure-switching effects. At the time, I did not think very much about these, but clearly they are significant and -- like anyone else who's followed the real world -- I realize that now.
For instance, it's clear that changing the tax treatment of capital gains, or lowering marginal income tax rates, will change the way income is reported, particularly among high-income people. The large increase in measured income inequality in the US that occurs around 1987 in income data seems, to me, suspiciously like an effect of the tax law rather than of anything that happened in 1986 or 1987, which were otherwise fairly uneventful years, at least until the stock crash in October, 1987.
Likewise, the decision in 1986 to end the deductibility of everything but mortgage interest was fundamental to an acceleration of homeownership rates, which started that very year and has been going on since. Lowering personal income tax rates at the top also meant that income would shift from business uses (those corporate Rolls-Royces Craig Roberts saw in England, but also the skyscrapers of New York) into household uses (and CEO pay).
After the internet crash, these effects combined. It's an irony of Craig's position that when the Bush tax cuts were made in 2001, the effect was, in substantial part, felt in the market for mansions.
Bruce's truly telling argument against the Keynesian position is that we could not deliver. And here, of course, he has me to rights, because (as he knows), there was a deep split among those who considered themselves Keynesians on what it would take.
The dominant American Keynesianism restricted itself to a very limited set of tools: tax cuts, spending increases, and interest rate manipulations. They were willing to tolerate wage-price guidelines but only barely. My first published article, in 1978, was entitled "Why We Have No Full Employment Policy;" it examined the limits to what these people were prepared to do.
On the other hand, the really crude and vulgar types, notably in my circle my father and Henry Reuss, were willing to intervene much more forcefully, selectively and (we thought) effectively. JKG and HSR, and many others of their generation, had worked on the World War II mobilization, with impressive results. They therefore did not share the policy pessimism of either mainstream Keynesians or the supply-siders.
Were they right? We should distinguish between what is technically possible and what is politically possible at any given time.
Part of the reason my father attracted so much derision, over the years, from both conservatives and mainstream liberals is that he threatened their authority, and not merely by attracting a large audience to his writing. He'd had the experience of directing a policy (war-time price control) that truly did change the world, and his adversaries did not much want to have that remembered.
So I think that well-designed policy can, in principle, change things fundamentally. Exactly what policy? That depends on the problem and conditions at any particular time.
A truly Keynesian view, after all, holds that there is no fixed formula; policy design should be adapted to the circumstances of the challenge. The job of the economist is to work out what the circumstances are, what should be done, and also how best to make it politically possible to do what is needed. (This makes our job complicated, but interesting.)
Will the chance come around again? Climate change may give us a chance to find out.