Chapter 16 Stagflation and Supply-Side Economics

I. Understanding Stagflation

II. Stagflation of the 1970's

III. The Misery Index

IV. Stagflation Created Supply-side Economics


V. Reaganomics

VI. Effectiveness

See U.S. Economic Normality 1945-201

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I. 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.


          e. The Phillips Curve Key Concepts in 60 sec video
          f. Will the Real Phillips Curve Stand Up  04/04/11
          g. Phillips Curve Flattens, but Steepened in States 0/5/20

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 lowering 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.
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

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 =

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
              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
          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.
Everyone loves Paul Volcker. Everyone is wrong.

     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

           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. Contraction 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
          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
          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
    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
         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
             f. The government increased dramatically funding semiconductor
                 and network research.
Who caused what?


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)
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. 
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
            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
             j. Different views of the act
2001 Tax Cut an in depth look.
Analysis of Final Bush Tax Plan

2001 Tax Cut Made a Difference
                     is what
most  conservatives feel 5
                     years later.
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.

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


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

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

Image result for Supply Side Cartoons




































Less Regulation Might Help

Editor's Question Will this Lowers Cost go to Profits, Wages, Both           


Significant Regulations Completed
by Presidential Year graph

Number of Economically Significant Regulations Completed by Presidential Year graph















Lets Stop Lying About Money

Stephen Moore wrote as a member of the Wall Street Journal editorial board:

"... Reagan chopped the highest personal income tax rate from the confiscatory 70% rate that he inherited when he entered office to 28% when he left office and the resulting economic burst caused federal tax receipts to almost precisely double: from $517 billion to $1,032 billion."

"This is wrong. Partly thatís because Moore didnít even use figures from Reaganís first and last years in office. But mainly itís because he didnít account for inflation or population growth. Once you do that, it turns out that federal tax receipts actually went up 14 percent on Reaganís watch, or 1.7 percent per year." See

Bush tax cuts Extension by Obama

Congress acts to delay 2014 Medicare Physician Fee





























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

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