Chapter 16 Stagflation and the Rise of Supply-Side Economics
A more concise
One-Page Test Review of Chapter 16 may help with exams.  
Updated 9/8/17  

Updated 9//1517                Please  
 

I. Understanding Stagflation

II. Stagflation of the 1970's

III. The Misery Index

 

 

IV. Supply-side economics originated because of stagflation

V. Reaganomics

VI. Effectiveness of Reagan's Supply-Side Economics

See U.S. Economic Normality 1945-201

 

Misery Index = Inflation + Unemployment  = 6.34% on 8/17

I. Understanding Stagflation
    A. Keynesian interpretation
        1. Inflation and unemployment change in opposite directions
        2. Correlation existed for four decades and was depicted by  English economist
            
Edmund Phelps in what became known as the Phillips Curve.
            a. He depicted an inverse relationship between changes in wages and changes in unemployment.
            b. Today the Curve is used to depict changes in consumer prices and unemployment.
            c. The Curve points out the inconsistency of both low unemployment and low inflation as economic goals. 
            d. A trade-off between the two is required because the factors necessary for low unemployment cause
                high inflation and vice versa.

A Phillip Curve Primer 5/29/17

 

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

Unit I Review Low 1970's Aggregate Demand as expected caused
slow growth but it did not slow increasing inflation.

B. Stagflation of the 1970's
        1. High unemployment and high inflation during the 1970's was not easily explainable with
             Keynesian theory which emphasized aggregate demand.
        2. High unemployment caused by low aggregate demand typically results in low inflation.
        3.  The Phillips Curve had moved to the right during the 1970's as both inflation and unemployment increased.
             a. Prices increased primarily because AS had decreased (shifted left).
             b. Unemployment increased because of slow growth in aggregate demand.

   

II. The origin of stagflation during the 1970's
     A. OPEC monopolized oil prices.
     B. Inflationary psychology, the feeling that prices would always increase substantially,
          resulted because of the high inflation during the Vietnam War and OPEC price fixing.
          To some degree, society acquiesced to inflation.
     C. Wage-price controls put on in the early 1970's to artificially limit the Vietnam War
          inflation were lifted. Once these artificial constraints to market activity were
          removed, prices increased dramatically.
     D. Productivity declined because of an influx of inexperienced workers (baby
          boomers and women) and the transformation of our economy from a
          manufacturing base (with its high productivity) to a more service-oriented
          base with its low productivity.
  
E. Check out AP Macroeconomics Review Materials!

Unit II Review Vietnam War deficits, two oil embargos and
low productivity led to low growth with inflation.

III. The misery index, which equals the unemployment rate plus the inflation rate, is
     an attempt to measure overall economic well-being. (Data from 1991 and 2000
     Economic Report of the President, 1992 Statistical Abstract of U.S., Economic 
     Trends published by the Federal Reserve Bank of Cleveland and Federal Reserve
     Estimates. Data was averaged by the author with the 1940's average taken from
     years 1941-1950, etc.

Unit III Review Unemployment + inflation up from 7.5% in 1960's,
 to14.3% in 1970's,
11.8% in 1980's and a more normal
 8.7% in 1990's. For 8/16 it was 5.7%.

OPEC Caused Gas Lines

Image result for Wage Price Controls pictures

 

See  Misery Index

Misery Index by Year

(1948 to 2010)

Unemployment Rate
By Year (1948 to 2010)

Inflation Rate By Year (1948 to 2010)

U +  

 I =

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

Misery index from - Wikipedia has interesting information.

Getting Better Since 2010

IV. Supply-side economics originated because of stagflation
      A. Supply-side economics described three key problems causing slow
           economic growth.
          1. High taxes are a fundamental problem, especially high marginal
              rates.
              a. They decrease incentive to work and save.
              b. They cause cost-push inflation.
          2. High transfer payments lower worker incentives.
          3. Government regulation is expensive and counterproductive.
      B. This would stimulate high noninflationary economic growth by
          increasing AS. 
      C. Here is one estimate of the cost of government regulation.
      D. For the cost of regulation visit 

      Office of Advocacy, U.S. SBA, The Impact

Unit 4 Review Reagonomics stated high taxes increased
government regulation, lowered productivity and investment.

Image result for Stagflation Cartoons

 

 

V. Reaganomics
     A. President Reagan attempted to eliminate the causes of stagflation
          by instituting supply-side economic policies.
     B. These were the key ingredients of President Reagan's economic
          policy.
          1. Supply-side policies
              a. Lower government expenditures on social programs
              b. Reduce government regulation 
              c. Cut personal and corporate taxes, especially high marginal
                  tax rates
          2. Monetary policy: President Reagan did not discourage the
               Federal Reserve from their continued attempt to lower inflation
               with a tight money policy.
     C. Keynesian economics predicted lower taxes would increase the
          already high rate of inflation.
     D. Many predicted high deficits, economist Arthur Laffer disagreed.
          1. Laffer Curve
          2. Lowering the tax rate from X to X' would increase tax receipts.
              a. Lower tax rate would lessen avoidance of taxes.
              b. Fewer transfer payments due to tougher welfare policies
                  would result in more people working and paying taxes. 
              c. Overall effect of the program would be higher productivity. 
                  This would increase AS causing GDP and tax revenue to
                  increase.


           3. The Laffer Curve- Economic Theories in 60 seconds
      E. Liberal Richard Wolff On Reaganomics

Unit V. Review  cut taxes and regulations and he let the FED
kill inflation resulting in
the first Great Recession in the early 1980's.

VI. Effectiveness of Reagan's Supply-Side Economics
      A. Contractionary effects of tight money came earlier than the
           expansionary
           effects of a tax cut and the result was two recessions from
           1980-83.
      B. Short-term results were good.
          1. Inflation dropped dramatically although much of the credit
              must go to the Federal Reserve which began tightening in
              1979.
          2. Unemployment eventually came down.
          3. The longest peacetime expansion in history resulted although
               critics point out that the large increase in military spending
               during the early Reagan years made for high peacetime
               defense budgets.
     C. Supply-side effects may have been negligible.
          1. Aggregate supply moved little as productivity increases were
              small. 
          2. Saving went down (though much of the drop in saving had
              demographic causes as baby boomers borrowed to furnish
              homes, many of which
              were investment type multifamily dwellings.
     D. Some results seemed bad, especially at the time. 
          1. Large federal deficit resulted (in part because inflation came
              down much faster than expected lowering tax revenues).
              Many felt these deficits would compete with (crowd out)
              private investment for many years.
         2. The trade deficit increased. 
              a. The problem began when an increase in borrowing by
                   businesses, individuals, and the federal government
                   caused high interest rates. 
              b. High interest rates combined with a drop in inflation and
                  an economic recovery making U.S. investments attractive
              c. The resulting high foreign demand for the dollar pushed
                  its value up making imports cheaper and exports more
                  expensive.
    E. Opinions differ as to the overall result.
        1. Some think the recovery was a typical Keynesian demand-side
            phenomenon (i.e., deficit spending) See
Trickle Down Economics
        2. Supply-side economists point to a number of improved conditions.
            a. The increase in manufacturing productivity indicates supply-side
                 economics worked.
            b. Comparing saving rates for countries is difficult as different
                accounting procedures are used to measure saving.
            c. When Reagan left office, the average United States citizen
                earned about 25% more than the average citizen of Germany
                and Japan. 
                1. Data based upon purchasing power parity and not the
                    international exchange rate of the dollar. 
                2. Critics point to a widening income gap between rich and
                    poor.
         3. Other things happened that affected economic activity.    
             a. Industry was deregulated. 
             b. Intellectual Property rules were rewritten.
             c. Pressure was put on the Soviet Union by enhancing the
                 military buildup started by President Carter.
             d. Striking air traffic controllers were fired.
             e. Social Security funding was enhanced with benefit cuts and tax
                  increases. 
             f. The government increased dramatically funding semiconductor
                 and network research.
             g.
Who caused what?

         

Review Unit VI. It worked or was it large Keynesian deficits? 

 

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

 

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

 

 

 

 

Image result for cost of Regulation data

Editors Note: Material supplied by
anti-regulation advocates.

 

Editors Note: The great inflation of the 1970's
 made the CPI a less valuable inappropriate measure
 for calculating wage growth .

 

 

 

 

F. Recent tax reforms
  
1. Economic Recovery Tax Act of 1981
         a. Cut personal tax rates by 25% over three
             years
          b. Reduced capital gains tax rate below
               that paid on ordinary income
          c. Allowed for a more rapid write-off of
              capital (accelerated depreciation)
          d.
Tax Cuts Don't Pay for Themselves 8/30/17
      2. Tax Reform Act of 1986
          a. Lowered top rates from 50% to 28%
          b. Increased the tax base by doing away
              with many tax loopholes
        3. Budget Accord of 1990
            a. Increased the top tax rate to 31%.
            b. Increased regressive excise taxes.
        4. Tax Increases of 1990 and 1993
            a. Taxes were increased to lower the
                deficit.
            b. Hope was a lower deficit would
                lower interest rates.
            c. Interest rates came down, other
                things happened to
                foster a strong economy, and the
                deficit (ignoring the long-term social
                security liability) disappeared. 
         5.
Economic Growth and Tax Relief
          Reconciliation Act of 2001 and
       the 2003
 

             a. highest income tax rates: the 28,
                 31, and 36 percent rates fall by 3
                 percentage points, while the 39.6
                  percent rate falls to 35 percent.
             b. A new 10 percent tax bracket is
                 carved out of the 15 percent bracket.
             c. Although the cuts in the highest
                 income tax rates phase in slowly,
                 the 0 percent bracket is available
                 immediately.
            d. The tax act also expands the child
                 credit and the Earned Income Tax
                 Credit (EITC)
             e. reduces marriage penalties
             f. increases subsides for education
                and retirement saving
             g. repeals the limitations on itemized
                 deductions and phase outs of 
                 personal exemptions
             h. provides temporary, limited relief
                 from the alternative minimum tax
                 (AMT), a complex law that was
                 designed to prevent aggressive
                 tax sheltering but primarily affects
                 large families or residents of states
                 with high income taxes.
             i. The tax act reduced the estate tax
                and generation skipping tax between
                2001 and 2009 and repeals them in
                2010.
             j. Different views of the act
                 1)
2001 Tax Cut an in depth look.
                 2)
Analysis of Final Bush Tax Plan

                 3)
2001 Tax Cut Made a Difference
                     is what
most  conservatives feel 5
                     years later.
                 4)
Kennedy Reagan, Bush tax-cuts
                 5) Bush Administration Assessment
                     6) Republican Tax Cut Myth 4/28/17

    6. Jobs and Growth Tax Relief Reconciliation
      Act of 2003
     
    a. Lowered long term (over one year)
                   capital gains taxes from 20% to 5%
                   for those in the lowest two brackets
                    (Under $65,100 for married filing
          jointly in 2008
)
                    and 15% in higher brackets.
       
b. Most rate reductions would expire if
                    not extended by 2010.
               c. Primary residence is excluded to
                   $250,000 ($500,000 married filing
                    jointly) if held two of the five years
                    prior to the sale.

Image result for Supply Side Cartoons

 
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