Ronald Reagan's Economics

I don’t think Jane has her history right. Volker was appointed by Carter. But he was not Carter’s guy. Volker had been the president of New York Fed and was well respected in banking circles, but he had no political portfolio.

At the end of 1979 the country was in a very bad financial crisis. Inflation exceeded 1% a month, commodity prices spiked including oil and gold (which hit a record of $800+ in Jan 1980, the date I bought my wedding ring, people wer lined up down 47th street and around the corner to sell gold, I calculated that the Federal reserve system could have liqudated its gold holdindgs at that price and paid off its balance sheet liabilities).

Interest rates shot up. When Carter took office in early 1977 the prime rate was 6.25%, in early 1978 it was 8%, in early 1979 it was 11.75%. These numbers come from This Link

With inflation at 12% that was not really tight money.

Volker was appointed in August, 1979 by Carter as a signal to finacial markets that Carter and his team of incometent bimbo’s were not going to interfer in monetary policy anymore. By the end of September the Prime Rate hit 13.5% and 15.25% by the end of the year.

Volker was not done. By April 1980 the prime rate had reached 20% (In New York at the time it was a felony to lend money at any rate in excess of 25%). We were married that month and we signed a mortgage commitment at 17% (we closed later in the summer at 13.5%) 24 years 3 children one move and many refinancings later we are at 5.75%.

There were two years of stringency left. Reagan could have organized a coup against Volker, but he did not. here is what Volker had to say:

INTERVIEWER: What was President Reagan’s stance toward what you were doing?

PAUL VOLCKER: I saw him from time to time, but I was not a close intimate of President Reagan’s. His entourage in the White House, or certainly in the Treasury, were very critical at times. They were… kind of a funny mixture. They had monetarist doctrine, supply-side doctrine, libertarian doctrine all mixed together, so some of it wasn’t terribly coherent, which helped me a bit. There was unhappiness because there was a big recession early in his term, and things were not really stable. But he himself never criticized me directly in public, certainly. I always had the feeling that he was urged to do so. [It seemed] that every time he had a press conference somebody was urging him to take a slap at the Federal Reserve, but he never did, and I don’t know why. I speculate that he was not a highly sophisticated economist. I’m sure he didn’t understand all the arguments his own people were giving him. He did understand that he didn’t like inflation, and I think he had some kind of a feeling that the Federal Reserve was trying to deal with inflation.

INTERVIEWER: In the late years, was there a Reagan revolution?

PAUL VOLCKER: I think there was a Reagan revolution in terms of the cutting edge of this moving back from this feeling that [if] you’ve got a problem, the government would answer it. Here’s a big brother here to help you, as Mr. Reagan used to mock, but if it’s true that we needed some cutting back in this exuberant view of government, which I happened to share, he certainly did it with some vigor. He did it in a way that helped restore the confidence of America in America, which had been lost, or at least greatly eroded, during the 1970s.

INTERVIEWER: Was the air traffic controllers’ strike a watershed?

PAUL VOLCKER: Yes, I think it was, and that’s not often appreciated. One of the major factors in turning the tide on the inflationary situation was the controllers’ strike, because here, for the first time, it wasn’t really a fight about wages; it was a fight about working conditions. It was directly a wage problem, but the controllers were government employees, and the government didn’t back down. And he stood there and said, “If you’re going to go on strike, you’re going to lose your job, and we’ll make out without you.” That had a profound effect on the aggressiveness of labor at that time, in the midst of this inflationary problem and other economic problems. I am told that the administration pretty much took off the shelf plans that had been developed in the Carter administration, but whether the Carter administration ever would of done it is the open question. That was something of a watershed.

Text Link

But I think Reagan deserves the credit for executing one of the fundamental tasks of a leader. When one of your subordinates is doing something good. Let him do it. Don’t let other members of your team with other agendas stop him.

I agree completely Arnold that “Reagan’s greatest economic policy was the decontrol of oil prices.” Reagan decontrolled oil and natural-gas prices almost immediately upon moving into the White House. No sustained shortage of these things has since reared its ugly head in the United States.

Several years ago my wife, Karol, was in the graduate history program at the University of Georgia. She served as a teaching assistant for a large-section freshman class on American history. The text for the class was David Shi’s and George Tindall’s America: A Narrative History.

I recall perusing this text and reading in it that one of the benefits that Ronald Reagan enjoyed during his first term as president – a benefit that eluded Jimmy Carter – was that the gasoline shortages that marked the 1970s stopped occurring in the 1980s. Shi and Tindall wrote of this fact as if it were a merely lucky happenstance for Reagan’s presidency, a fortunate fluke that had nothing whatsoever to do with a policy change.

Anyone who writes of these shortages, and their disappearance, as if these phenomena are forces of nature is an economic ignoramus of the first fiber. Reagan, for all of his imperfections, saved Americans from the wholly unnecessary and extraordinarily costly and counterproductive price-caps that juvenile minds believe to work magic.

The worst legacy left Us by Reagan was the concept that Deficits do not matter. Deficits of Government–Federal, State, Local–generate 80-90% of all inflationary pressures. The rest of the inflationary pressures come from the lack of taxation. Fixation on fictional tax rates which are never paid is a stupidity. This Country, plus its economic expansion, would be saved by a real tax rate upon Individuals of 15% plus a Business real tax rate of 20%. The ‘real’ in this case maean taxes which are actually paid. lgl

“Milton Friedman thinks that Reagan deserves credit for supporting Volcker, but in fact Volcker’s position was impregnable.”

I don’t understand the “but”.

Volcker’s job security may have been pretty solid but that doesn’t mean he had a free hand to do whatever he wanted — like raise rates to 20% through monetary targeting — without other people in government agreeing.

In his book he makes clear that the switch to monetary targeting needed political support to be implemented, recalls the lobbying he did to get it, states that the Treasury and CEA heads were against it, and that getting the go-ahead from Reagan was key to getting through the politics and doing it.

As an aside, I’ve seen a good number of people say (even in Fed papers) that Volcker never did really switch to monetary targeting, it was just a ruse to make it politically acceptable to raise rates as high as he wanted.

These folks never site his memoirs on it though, and if they’re right he’s either quite a liar about that time period or did a whole lot of lobbying for nothing.

Among other things he says in retrospect that raising rates the conventional way wouldn’t have worked for lack of political support (impregnable position or not)…

“The general level of interest rates reached higher levels than I or my colleagues had really anticipated. That, in a perverse way, was
one benefit of the new technique: I would not have had support for deliberately raising short-term rates that much…”

“Cutting taxes without cutting spending” isn’t supply side economics – it is Keynesian economics. Classic supply side economics doctrine is to cut marginal tax rates, either by reducing revenues, or by broadening the tax base. By doing so one stimulates “supply” – Supply of labor increases, because workers keep more of their marginal income, supply of product increases, because firms keep more of their marginal profit, supply of capital increases, because people keep more of their marginal interest.

This is precisely what the 1986 reforms did – they lowered marginal rates, but eliminated unnecessary deductions to broaden the tax base – they were classic supply-side policy. (And they worked, quite well – whether that was due to the Keynesian or supply-side aspects or something else, I do not know, though I have my suspicions.)