For economists, the Reagan era has been both fascinating and disconcerting. In 1980, Keynesians were in full retreat. Although the nasty combination of unemployment and inflation--Paul Samuelson's "stagflation"--could reasonably be explained as mostly the consequence of OPEC's 1973 and 1979 price shocks, Keynesians too recently had been making self-confident claims that the economy could be fine-tuned by judicious tax and spending policies to escape the derision of their opponents. The Carter presidency was held up, on the whole unfairly, as a symbol of the inadequacy of Keynesian analysis in a disordered world economy.
Accordingly, the ideological door was open to experiments with non-Keynesian policies. The monetarist experiment began with the appointment of Paul A. Volcker as Federal Reserve Board chairman in 1979.
Volcker announced that henceforth the Fed would cease manipulating the federal funds rate and focus entirely upon the monetary aggregates, above all Milton Friedman's favorite M-1. The monetarist prescription was appealingly simple. Central bankers needed do no more than announce their M-1 targets and make sure that they hit them. As events soon demonstrated, targets were easier to announce than to hit.
In the Reagan official family, monetarists were well-represented, especially by Treasury Undersecretary Beryl Sprinkel (later Council of Economic Advisers chairman), but so also were supply-siders.
Our cheerful President became an early convert to a doctrine that trumpeted lower taxes (especially on large incomes) as the magical key to more saving and investment, higher productivity, faster growth, rising living standards and even a budget soon to be balanced out of the abundant tax revenues from a booming economy.
Life is notoriously untidy. The two new initiatives overlapped and conflicted. The fruits of the Fed's romance with monetarism were the 1981-82 mini-depression, the sharpest contraction in the post-World War II era. Supply-siders could legitimately complain that the Fed had sabotaged the three-year Kemp-Roth tax cuts before their impact could be felt.
The plot, as plots do, thickened. The Fed abandoned monetarism in late 1982 and returned to its historic posture of eclectic concern for interest rates, the solvency of the banking system and the health of the economy. Since then, the economy has been steadily expanding. The current upswing has lasted longer than any similar episode since the 1960s--the high point of Keynesian self-confidence.
Now, at last, the supply-siders had a chance to test their sovereign remedy. They fared no better than the discredited monetarists. Last August, Americans saved 1.5% of their disposable income, a historical low. Business investment in plant and facilities continues at rates far below those of Japanese or West German competitors. Our persistent trade deficit attests to the preference of Americans for foreign merchandise even after two-plus years of dollar depreciation.
In real terms, wages have been steadily declining in sharp contrast to previous upswings. Only this year has unemployment diminished to 6%, a figure that not long ago signaled recession and set alarm bells ringing in Washington.
Japanese and other investors own an increasing fraction of our national debt and a significant quantity of prime real estate.
The Fed is compelled to keep interest rates high, lest the foreigners buy fewer Treasury securities and abruptly call the consumer celebration to a halt.
An unstable phenomenon, the consumer spending binge is also fueled by a vast accumulation of family debt, the entry of women into the labor force as second wage-earners, the sense of affluence stimulated for homeowners by rising property prices and, for stockholders, by the protracted bull market.
It is an open question how much more debt consumers can shoulder. The female labor force participation rate is already so high that it is questionable how much further it can ascend. And a great many people will feel much poorer when the stock market bubble bursts.
The irony of it all is this: The long upswing in the business cycle is an utterly Keynesian phenomenon. As the master predicted, consumers will spend almost all of any improvement in their disposable income that comes their way.
Make Fewer Claims
A doubled Pentagon budget will entirely predictably enlarge payrolls and capital expenditures on the equipment needed to fabricate exotic weapons. The deficits generated by these two policies quite adequately explain our comparative prosperity, just as their elimination would write its obituary.
Keynes preferred civilian to military spending and taxes on the affluent to imposts on their financial inferiors. Nevertheless, for better or worse, military Keynesianism has produced a kind of prosperity, at the expense of equity and civilian productivity.
As Princeton economist Alan Blinder persuasively argues in his forthcoming "Hard Heads, Soft Hearts," the "old" economics--the combination of Keynesian fiscal policy and private free markets--is back.
Keynesians, properly chastened by recent adversity, now make fewer claims of their capacity to delicately adjust economic malfunctions, but they can be justly reassured alike by the failures of monetarists and supply-siders and the plausible interpretation of Reagan prosperity in Keynesian terms.