Reaganomics: An Analysis

Ronald Reagan came into office on January 20, 1981. He left office on January 20, 1989. His economic policies are often dubbed Reaganomics, but in reality the various economic policies put into effect during his presidency were an eclectic mix of sometimes conflicting doctrines.

I have to say I doubt whether the “Great Communicator,” who was allegedly showing increasing symptoms of Alzheimer’s in his years as president, ever properly understood the hybrid nature of his administration’s economic policies.

In truth, Reagan’s economic policies were run by his advisers, and by competing factions in his administration, including (1) monetarists, (2) supply-siders, and (3) fiscal conservatives. Different factions had different agendas, and one faction had greater dominance over others at certain times.

The Supply-Siders in the administration were Arthur Laffer, Martin Anderson, and Paul Craig Roberts. They appear to have been supported by Don Regan, Secretary of the Treasury from 1981–1985, and the President to some degree.

David Stockman was a fiscal conservative, who opposed the Supply-Siders on their tax cuts late in 1981 (Roberts 1984: 186–187; 191–192). This opposition was made worse after his interview with the Atlantic Monthly published in December that year (W. Greider, 1981. “The Education of David Stockman,” The Atlantic Online), which appears to have been an attempt to discredit the Supply-Siders (Roberts 1984: 192–193).

In the late 1980s, the outstanding Post Keynesian economist Alfred S. Eichner published a critical article analysing Reaganomics (Eichner 1988: 541–556). I base this post on his analysis.

Eichner divided the neoliberal or conservative economic factions in the Reagan administration into the three groups I mentioned above:

“1. the monetarists, committed to the proposition that limiting the growth of the money supply is the only way to bring inflation under control;
2. the “supply-siders,” arguing for lower tax rates (and, subsequently, lower interest rates) as the best means of boosting the economy’s long-term growth rate; and
3. the fiscal conservatives, concerned primarily with balancing the federal budget” (Eichner 1988: 544).

Furthermore, the early Reagan administration was characterized by two periods, which Eichner describes as follows:

“(1) the period from the first quarter of 1981 through the second quarter of 1982, during which the Reagan administration merely pursued with greater vigor policies begun under President Carter, and
(2) the period since then, marked by a reversal of the previously restrictive monetary policy and the delayed impact of the radically expansive fiscal policy the Reagan administration succeeded in pushing through Congress shortly after taking office”(Eichner 1988: 543).

I think all this is essentially correct.

Reagan’s economic policies can be divided into the (1) monetarist (or at least quasi-monetarist) period from 1981 to 1982, and (2) the supply-side period from 1982 onwards.

Let’s review these two periods below.

I. Volcker’s Quasi-Monetarism (1981–1982)
The monetarist period was directed by Paul Volcker from the Fed, and it was actually a continuation of the monetarism that he had begun under Jimmy Carter in 1979. Far from being an innovation of Reagan, the turn to monetarist doctrine was the fault of Carter (or, if you are a conservative, you might say the “credit” would have to go to Carter!).

In 1979–1981, the world experienced the second of the oil shocks, and serious double digit inflation.

Some policy-makers like Thatcher and Carter decided to adopt the elements of Milton Freidman’s monetarist doctrine to control inflation by controlling money supply growth. The essence of this is the belief that “inflation is always and everywhere a monetary phenomenon,” and that central bank control of the money stock or its growth rate will control inflation rates, with minimal loss of output growth and minimal unemployment.

But, as Post Keynesians know, it is a myth that the central bank directly controls the broad money stock or its growth rate.

Nevertheless, Paul Volcker attempted a monetarist experiment from 1979–1982, by trying to control the growth rate of M1, through targeting non-borrowed reserves. The orthodox monetarists complain that since Volcker never adopted a constant money growth rule during his experiment in 1979–1982 the period was not really “monetarist.” This is implausible. There is simply no doubt that Volcker’s policy was a departure from normal monetary policy, and that

“… during the 1979–1982 period, the Fed was concerned with money growth and not with fine-tuning real economic activity—behavior we have described as quasi-monetarist” (Hakes and Rose 1992–1993: 286).

This quasi-monetarist policy is surely an approximation of a pure monetarist constant money growth rule, and there must be something to be learned from an approximation of an economic theory.

In fact, the lesson we learn is that Volcker’s quasi-monetarism was a miserable failure, with the Fed badly missing its M1 targets (Wray 2003: 92). The Fed simply could not control M1, but this should come as no surprise to advocates of the endogenous money theory.

What actually happened under Volcker is that his “floating” interest rate policy caused the federal funds rate to soar to 19% by June 1981, inducing two severe recessions, the first from January to July 1980, and the second from July 1981 to November 1982. This caused mass unemployment, crippled American manufacturing enterprises in the Midwest, and a Third World debt crisis (Galbraith 2009: 38), as the American recessions and high interest rates essentially caused a global recession (Eichner 1988: 548). The high interest rates in the US also lead to a damaging appreciation of the US dollar late in 1980, which hit US exporters hard (Eichner 1988: 549).

The recessions, the US demand contraction and steep fall in the price of oil (which can be seen in this graph) were the real reason US inflation fell from a peak of 14.8% in March 1980 to 4.6% in November 1982, and not because money supply growth rates were brought under control in the way imagined by monetarism or the quasi-monetarist targeting Volcker pursued.

At this point, I turn to Paul Craig Roberts’s memoir The Supply-Side Revolution (Harvard University Press, 1984). Roberts was a leading supply-side economist, and Assistant Secretary of the Treasury for Economic Policy from early 1981 to January 1982, under the Treasury Secretary Donald Regan.

His account of the monetary policy the Reagan administration had demanded of the Federal Reserve on taking office in 1981 is worth quoting:

“Secretary Regan, Undersecretary Sprinkel, and I are on the public record in testimony before Congress stating that our monetary assumption and the policy we requested from Federal Reserve Chairman Paul Volcker was a gradual 50 percent reduction in the growth rate of the money supply spread over six years. Yet, oddly enough, when I testified before the Senate Budget Committee on March 5, 1982, Chairman Domenici was surprised to hear my statement of the administration’s monetary assumption. He seemed to think that we had supported the very tight monetary policy during 1981, when Volcker collapsed the growth of the money supply to zero for six months of the year….” (Roberts 1984: 115–116).

“The day after the Reagan inauguration, Treasury was asked to prepare a short memo on the subject of new President’s message to Volcker. The memo read:

There is no way the President can carry out the main points of his administration …. Unless the Federal Reserve provides the right kind of monetary policy. The right policy is stable moderate and predictable money growth … Volker should manage the affairs of the Fed so that uncertainty is reduced … There is no excuse for failure. If the Fed fails, the Reagan Administration fails.

Unfortunately our fears were realized. Instead of evenly spreading the reduction in money growth over a six-year period, the Federal Reserve delivered 75 percent of the reduction in the first year. In November 1981 the Treasury staff reported that the main monetary measure, called M1-B, which consists of currency plus all kinds of checking accounts, had fallen over the previous six months, for only the second time since 1959–60. There was actually less money in the economy in October than there had been the previous April. The growth in M1-B over the year was meagre, roughly equivalent to figures for the recession years of 1970 to 1975. This was ferocious indeed and, with the tax cut delayed, recession inevitable (Roberts 1984: 116).

Two points emerge from this. First, Roberts claims that Volcker never implemented the monetary policy that Treasury demanded of him in 1981. Secondly, if the Reagan administration’s stated and intended monetary policy was never implemented, then in no sense can Reaganite apologists claim it was a success. A policy never even implemented cannot even meet the first criterion for judging the success of action, if one’s intended action was never even taken.

So Reagan and his administration deserve no credit for the fall in inflation rates that occurred in 1981 and 1982. That was the result of Volcker’s policies.

But, as we have seen above, the monetarist doctrine itself that Volcker adopted in 1979 did not even work properly. The Federal Reserve repeatedly missed its M1 targets, despite its quasi-monetarist policy. A deliberately-induced recession is what tamed inflation, and no Keynesian has ever said that high inflation cannot be brought down by causing a severe output and demand contraction, and by throwing millions of people out of work. The “Volcker shock” (as this period is now called) was a vicious and wasteful solution to the double digit inflation of 1979–1981, which inflicted totally unnecessary suffering on the millions of people made unemployed. Moreover, its effect (intended or not) was a savage blow against American manufacturing and working people in those industrial sectors. Another effect of the surge in interest rates was a crisis in the Savings and Loan industry and the push for deregulation in that sector, which culminated in the S&L crisis (see “Reagan Made S&L Crisis Vastly Worse”: William Black Interviewed on The Real News, February 8, 2011). (As an aside, an alternative, Post Keynesian solution to stagflation was incomes policy and, in the long term, commodity buffer stocks; see Musella and Pressman 1999: 1100; Kaldor 1976.)

Moreover, in October 1982, as disaster loomed, the economy was collapsing (and yet to even reach its trough), and Mexico was on the verge of defaulting (which would have bankrupted certain large US banks), Volcker abandoned his quasi-monetarism and returned to a discretionary interest rate policy, through the Federal funds rate (which had always been the main policy instrument before 1979). The Federal funds rate was lowered significantly by the end of 1982.

Years after this disaster, Milton Friedman was interviewed by the Financial Times (7 June 2003). He stated: “The use of quantity of money as a target has not been a success, ... “I’m not sure I would as of today push it as hard as I once did.” Pity it took him 21 years to realise what was obvious to many other people.

II. Supply-Side and Military Keynesian Period, 1982–1989With the collapse of quasi-monetarism at the Fed, the Supply-siders in the administration came to have more influence, especially after Reagan overruled the fiscal conservative David Stockman in November 1981 (Roberts 1984: 193).

In 1981, the “Economic Recovery Tax Act” had already passed Congress on August 4 and signed by Reagan on August 13.

But, as Eichner notes, US fiscal policy under Reagan in fiscal year 1982 was Keynesian, because of automatic stabilizers:

“The reduced tax revenues and the resulting budgetary deficits—at the state and local level as well as at the federal level—nonetheless served to cushion and eventually even to help reverse the cyclical downturn. To this extent, fiscal policy continued to function as an automatic stabilizer” (Eichner 1988: 548).

This countercyclical fiscal policy was significantly increased by Reagan’s discretionary spending on defence, and more so by the 1981 tax cut, which increased aggregate demand while government spending was rising. Eichner states:

“The rationale for the 1981 legislation was the “supply-side” argument that a reduction in tax rates would encourage greater savings, leading to a higher rate of capital formation. The savings rate has, however, declined sharply since 1981. Personal savings are currently only 3 percent of disposable income. No less embarrassing for the supply-siders has been the behavior of business investment. While expenditures on new plant and equipment have recovered from their precipitous fall during the recession and have even enjoyed a modest, though brief, boom, the trend growth rate remains unchanged at 3.5 percent” (Eichner 1988: 551–552).

“The lower tax rates have not generated more tax revenue as the supply-siders, pointing to the supposed Laffer curve, claimed they would. Indeed, it has been the failure of the lower rates to produce a larger tax yield and the resulting federal budget deficits which, in a more orthodox Keynesian manner, have provided the stimulus for the current economic expansion” (Eichner 1988: 553).

So what we in fact had was a supply-side faction in the Reagan administration whose policies, when combined with Reagan’s military spending, provided a Keynesian stimulus to the economy.

The recovery that began in December 1982 was caused by Volcker’s abandonment of monetarism and lowering of interest rates, automatic stabilizers, military discretionary spending, and tax cuts, which all drove the US budget into deep deficits. This is a standard package of Keynesian stimulus and its major component was countercyclical fiscal policy, though of course of a highly conservative variety. Reagan’s tax cuts favoured the wealthy and significantly increased income inequality in the US. Military spending was wasteful and inferior to social spending and public works.

The victory of military Keynesianism and huge budget deficits in Reagan’s presidency, and his failure to significantly cut total spending, is reflected by the disillusionment of one of the administration’s leading fiscal conservatives, David Stockman, the Director of the Office of Management and Budget from 1981–1985. Stockman resigned in 1985, thinking that the “Reagan Revolution” had failed.

As for Reagan, he continued until 1989, unaware to the end, I bet, that his policy mix after 1982 was unintentional, big-spending conservative Keynesian economics. Hey, big spender.


ADDENDUM: ROTHBARD ON THE SUPPLY-SIDERS

Murray Rothbard wrote a number of attacks on Reagan’s economics from the perspective of Austrian economics. I will quote him on the Supply-Siders:

“The other set of Reaganite deficit-apologists are the Supply-Siders. First, they don’t care about deficits, for they want only tax cuts, and they favor keeping spending levels high. The supply-siders are interventionists and not free-market advocates; they simply want different kinds of intervention. But they agree with liberals and Keynesians that spending levels should be kept high, largely because that is what they think the public wants. Professor Arthur Laffer, in his extreme Laffer Curve variant of supply-side, claims that cuts in tax rates, particularly income-taxes, will almost instantaneously raise tax revenue so much (because of increased work, thrift, and production), that this will achieve a balanced budget painlessly. Like the monetarists, the Lafferites demagogically promise painless economic adjustment; spending levels … can be kept up; tax rates can be sharply cut; and yet we can achieve a balanced budget through a rise in revenues”
Murray N. Rothbard, “Are We Being Beastly to the Gipper?”
http://www.lewrockwell.com/rothbard/rothbard55.html

It is indeed true that the Supply-Siders quickly became apologists for Reagan’s deficits, when tax revenues failed to be boosted significantly by the tax cuts of 1981.

Finally, it should be noted that, compared with the very extreme free market Austrians, everyone in their world is an “evil” interventionist – even mainstream Monetarists and Supply-Siders!

PAUL CRAIG ROBERTS ON SUPPLY-SIDE ECONOMICS

I have quoted the Supply-Sider Paul Craig Roberts above. He is worth quoting again on the nature of Supply-side economics:

“The two professional economists who had the first insights into supply-side economics were the University of Chicago trained economist, Norman Ture, and the Canadian economist, Robert Mundell, a Nobel prize-winner in economics ….

Supply-side economics corrects a fundamental mistake in Keynesian economics. Most everyone has heard of supply and demand, but Keynesian economics, known as demand management, left out supply ….

Supply-side economics established that fiscal policy shifted the aggregate supply schedule. In his famous economic textbook Nobel economist Paul Samuelson included me and a diagram showing that supply-side economics was an argument that fiscal policy shifted the aggregate supply curve in contrast with the Keynesian emphasis that it shifted the aggregate demand curve. Samuelson declared that the real argument was over the magnitude of the shift.

In other words, the most famous American economist of the 20th century accepted the supply-side theory and said its importance for economic policy depended on its magnitude. Several economists provided empirical evidence of the magnitude, but the disappearance of worsening trade-offs between employment and inflation settled the issue for most.

I myself debated most of the Keynesian Nobel prize-winners before university audiences or before annual meetings of economic associations. When the argument was presented to them, they understood the point and accepted it. I received a standing ovation when I gave the annual State of the Economy address at MIT. The story of how supply-side economics came to be can be found in my book, The Supply-Side Revolution, published by Harvard University Press in 1984.”
Paul Craig Roberts, “What is Supply-Side Economics? Bush Hides Behind Supply-Side to Reward His Cronies,” Counterpunch, February 25 / 26, 2006.

It seems to me that Supply-Side economics was seen by its supporters as essentially a complement to and correction of the neoclassical Keynesian synthesis.

It is surprising that a macroeconomic theory like Supply-Side economics, which shared many traits with the neoclassical synthesis, was so eagerly adopted by anti-government and fiscal conservatives as the basis of a “Reagan revolution.”


Appendix 1: Economic Policy-Makers Under Reagan

White House Chief of Staff
James Baker 1981–1985
Donald Thomas Regan 1985–1987

Chief Domestic Policy Advisor
Martin Anderson 1981–1982

Director of White House Office of Policy Development
Roger B. Porter 1981–1985

Economic Policy Advisory Board
Arthur Laffer 1981–1989
Martin Anderson 1982–1989

Chairs of the Council of Economic Advisers (CEA)
Murray L. Weidenbaum 1981–1982
Martin Feldstein 1982–1984
Beryl W. Sprinkel 1985–1989

Director of the Office of Management and Budget
David Stockman 1981–1985
James C. Miller III 1985–1988
Joseph R. Wright 1988–1989

Chairs of the Federal Reserve
Paul A. Volcker 1979–1987
Alan Greenspan 1987–2006

United States Secretary of the Treasury
Donald Regan 1981–1985
James Baker 1985–1988
Nicholas F. Brady 1988–1993

United States Assistant Secretary of the Treasury for Economic Policy
Paul Craig Roberts 1981–1982


BIBLIOGRAPHY

Eichner, A. S. 1988. “The Reagan Record: A Post Keynesian View,” Journal of Post Keynesian Economics 10.4: 541–556.

Galbraith, J. K. 2008. The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should too, Free Press, New York.

Greider, W. 1981. “The Education of David Stockman,” The Atlantic Online (December), http://www.theatlantic.com/doc/print/198112/david-stockman

Hakes, D. R. and D. C. Rose, 1992–1993. “The 1979-1982 Monetary Policy Experiment: Monetarist, Anti-Monetarist, or Quasi-Monetarist?,” Journal of Post Keynesian Economics 15.2: 281–288.

Kaldor, N. 1976. “Inflation and Recession in the World Economy,” Economic Journal 86 (December): 703–714.

Musella, M. and S. Pressman. 1999. “Stagflation,” in P. Anthony O’Hara (ed.), Encyclopedia of Political Economy: L–Z, Routledge, London and New York. 1099–1100.

Roberts, P. C. 1984. The Supply-Side Revolution: An Insider’s Account of Policymaking in Washington, Harvard University Press, Cambridge, Mass. and London.

Schwartz, A. J. 2005. “Aftermath of the Monetarist Clash with the Federal Reserve Before and During the Volcker Era,” Federal Reserve Bank of St. Louis Review, 87 (2 Part 2; March/April): 349–351.

Wray, L. R. 2003, “Monetary Policy: An Institutionalist Analysis,” in Marc R. Tool and Paul Dale Bush (eds), Institutional Analysis and Economic Policy, Kluwer Academic Publishers, Norwell, Mass. 85–114.