Thursday, June 23, 2011

What Was the Carter Economic Policy That Reagan Reversed?

Paul Krugman has to remind Greg Mankiw why we use business cycle peaks when trying to remove the effect of the business cycle:

So what you want is to somehow abstract from the business cycle. And the easiest way to do that is to compare business cycle peaks, times when the economy is at more or less full employment. True, employment is fuller at some peaks than at others, but those differences are small, whereas the depth of the slump at recession troughs is much more variable.

But there was something else Greg said that caught my eye:

Weren't the policies of those years precisely what Reagan was trying to reverse?

Perhaps but the most significant long-run macroeconomic change was the transition from the fiscal sanity exhibited throughout most of the 1950’s, 1960’s, and 1970’s to the fiscal irresponsibility of the 1980’s. During the earlier period, net national savings averaged approximately 10% of net national product whereas the national savings rate was about half of that during the 1980’s. I seem to recall in the first edition of Greg Mankiw’s macroeconomics text a very good discussion of how this reduction in the national savings rate increased real interest rates and crowded out investment. Which is one reason why average annual output growth fell from around 3.5% during the earlier period to around 3% during the period of fiscal irresponsibility. Which is of course the whole point when we discuss this Laugher curve insanity that somehow fiscal irresponsibility increases economic growth even though good economic logic says just the opposite.


JW Mason said...

This kind of anti-Keynesianism is just as foolish coming from liberals as coming from conservatives.

Keynes: "The investment market can become congested through shortage of
cash. It can never become congested through shortage of saving." Keynes was right. The Mankiw textbook is wrong.

Anyway, the post-1980 turn toward fiscal irresponsibility didn't happen. It's a figment of your imagination. The average primary balance 1954-1980 was a surplus of 0.1 percent of GDP. Average primary balance 1981-2007 was a deficit of 0.02 percent of GDP.

That's right, one tenth of one percent of GDP difference in fiscal stance before and after Reagan.

Total deficits were higher in the later period entirely because real interest rates were higher. Because what Keynes taught us -- and what Progrowthie here never learned -- is that interest rates are the price of liquidity, not the price of saving. As such, they are essentially conventional, tho the convention can be moved by a sufficiently persistent central bank.

The idea that there is a fixed supply of savings that can be used up by excessive government spending is believed only by people who have learned nothing from economics in the past 70 years.

JW Mason said...

(The decline in net national savings Progrowthie points to relate entirely to the changing behavior of households. There are lots of reasons for this change -- Steve Fazzari and Barry Cynamon have a good discussion here -- but fiscal policy ain't one of them.)

Ken Houghton said...

JW Mason - Not seeing that. If you take FYFR (Fed Revenues) - FYONET (Fed Net Outlays) and divide by GDPA, you get -1.20% for the first period and more than twice that (-2.55%) for the second period.

And that's including the four Clinton-driven years; take them out and the average goes to -3.28%.

JW Mason said...


Primary balance, not total balance. You have to subtract net interest expenditures from outlays.

You also should omit 2008-2010 from the post-1980 years. They pull the average up quite a bit, but presumably we don't think that stimulus in the Great Recession is reflective of a larger trend toward fiscal irresponsibility.

Look at (TGDEF+FYOINT/1000)/GDP in FRED. (Interest expenditures are given in millions rather than billions for some reason.) The late-90s surpluses are indeed exceptional, but the Reagan-era deficits are not; they're basically identical in magnitude to the primary deficits of the mid-70s. The total deficits under Reagan were of course much higher; but that is because interest rates were higher, not because of the gap between federal expenditures and federal taxes. In fact, the longer term trend toward from primary surpluses toward primary deficits halted, rather than accelerated, around 1980.

The real change around 1980 was that we moved from a low-interest regime favorable to the real economy to a high-interest regime favorable to rentiers. And that was thanks to Volcker, not Reagan.

Jasiek Jasiek said...

@JW Mason

Hi. It is my first time to join here.

Well, I'm afraid you must be missing the point that the 'saving' in the quote is different from 'net saving'.

I am not writing much. Instead, try and read the page 60 of General Theory (the version by Palgrave-MacMilan) in the first place, where Keynes emphasises the difference between saving and net saving, the former of which, not the latter, is important in employment theory as he says, and he criticises Fischer and Hayek on the notion of net income.

Jasiek Jasiek said...

@JW Mason

So, your understanding "The total deficits under Reagan were of course much higher; but that is because interest rates were higher" is not really pertinent if the "higher" means of absolute value.

Instead, we should interpret the then total deficits as "because interest rates were relatively high to the then schedule of marginal efficiency of investment".