Who remembers economists� hysteria over
the �Reagan deficits�? Wall
Street was in panic. Reagan�s fiscal irresponsibility was bringing the end of
The fiscal year 2009 federal budget deficit that Obama is
inheriting, and adding to, will be 10 times larger in absolute terms than
Reagan�s biggest and a much larger share of GDP in percentage terms. Yet,
economists are sending up no alarms.
Krugman, for example, couldn�t damn Reagan�s puny deficits enough. But
today he thinks the deficit can�t be large
The central issue of the stimulus and bailout plans is how
to finance the massive budget deficit. This issue remains unaddressed by
economists and policy makers.
As far as I can tell, the government, its advisers and
cheerleaders think financing the deficit will be a cakewalk, like the
I am tempted to claim that economists� nonchalance about the
massive deficit is an indication that Krugman and the whole lot of them are
converts to supply-side economics -- �deficits
don�t matter.� I triumphed, and economists have become my acolytes. The
Nobel Prize will arrive tomorrow.
Only we supply-side economists never said that deficits
don�t matter. We said that deficits have different causes and consequences. Some
are problematic. Some are not, or are less so.
Obama�s deficit is problematic. It is a massive deficit, far
beyond anything ever before financed on planet earth. It is arriving at a time when
pressures on the dollar as reserve currency have mounted from decades of rising
trade deficits. The deficit is hitting the financial markets when the rest of
the world is in turmoil from ingestion of toxic Wall Street financial
instruments. The US must service massive debt when the US economy is hollowed
out from the offshoring of manufacturing and professional service jobs. The
Obama deficit is a far more serious deficit than the �Reagan deficits.�
As President Reagan�s first Assistant Secretary of the
Treasury for Economic Policy, my job was to find and implement a cure for �stagflation.�
�Stagflation� was the word used to describe the worsening �Phillips curve� trade-offs between inflation and employment. The
postwar policy of Keynesian demand management relied on easy money to expand
employment and GNP, and used recession and unemployment to cool down inflation
when inflation got out of hand. Over the years, the trade-offs worsened. It
took more inflation to get the economy going, and more unemployment to cool
down the inflation.
This problem worsened during Jimmy Carter�s presidency. Reagan
used the �misery index,� the sum of the
unemployment and inflation rates, to boot Carter from office.
Keynesian economists concluded from the Great Depression
that the way to maintain full employment was for the government to manage
aggregate demand. If the sum of consumer and investor demand was not sufficient
to maintain full employment, government would step in. By running a deficit in
its budget, economists thought that government could add enough additional
demand to bring employment up to full.
The way this policy was implemented was to use easy monetary
policy to stimulate demand and high tax rates to restrain excessive consumer
spending that could push up inflation. The Keynesian economists did not
understand that the high tax rates contributed to inflation by restraining the
output of goods and services, while the easy money drove up prices.
Keynesians had no solution for the problem their policy had
caused, so Congress and President Reagan turned to supply-side economists who
offered a solution: restrain demand with tighter monetary policy and increase
supply with greater after-tax rewards.
Supply-side economics reversed the policy mix of demand-side
economists. Instead of easy money and high tax rates, there would be tighter
money and lower tax rates.
This change caused consternation. Keynesian economists, who
sat atop of the profession, bitterly resented the dethroning of their
orthodoxy. They turned on supply-siders with a vengeance. We were �voodoo economists,� �trickle-down
economists,� �tax cuts for the
rich economists.� Keynesians had been the great defenders of budget
deficits, but Reagan�s were intolerable. They forgot their own Kennedy tax rate
reductions. Supply-siders were bringing the end of the world.
Federal Reserve chairman Paul Volcker was part of the
problem. Volcker had limited economic understanding. He did not understand the
worsening boom-bust cycle that the Keynesian policy had set the Fed upon. He
viewed the Reagan tax rate reductions as a Keynesian stimulus to consumer
spending that would worsen the inflation, the subduing of which he saw as his
responsibility. He feared that the tax rate reductions would cause inflation
and that he would be blamed.
At the Treasury we had weekly meetings with Paul, attempting
to bring him into an understanding of what it meant to reverse the policy mix.
We patiently explained the importance of the Fed bringing money growth down
slowly as the tax rate reductions came into play in order to avoid a monetary
shock to the system.
Volcker just couldn�t get it. He thought the Reagan Treasury
consisted of dangerous inflationists. He went home to the Fed and turned off
the money supply, reasoning that if there was no money growth he couldn�t be
blamed for the inflation that Reagan�s fiscal policy would cause.
Volcker�s fears were reinforced by his advisors. As the
Treasury�s representative at the Fed�s meeting with its outside advisors, I
heard Alan Greenspan, Volcker�s successor, tell Paul that in view of the Reagan
tax rate reductions (which Greenspan also saw as a demand stimulus) �monetary policy was a weak sister that at
best could conduct a rear-guard action.�
It was amazing to us at Treasury that the Federal Reserve
chairman could not understand that monetary policy controlled inflation and
that fiscal policy, or the right kind of fiscal policy, helped control
inflation by increasing the output of goods and services.
But this was over Volcker�s head. Instead of giving us the
gradual reduction in the growth of the money supply, he slammed on the brakes. The
economy went into a serious recession just as Reagan�s tax cuts passed.
The embittered Keynesians wanted to blame the recession on
the tax cuts, but that was inconsistent with their own analysis. So they seized
on the deficits that resulted from the recession and blamed the tax cuts. This
was also inconsistent with Keynesian analysis. However, they used writings by
people who had popularized supply-side economics. Some of these people made
claims that �tax cuts pay for
themselves.� In other words, there would be no deficits.
No supply-side economist ever said this. And neither did the
Reagan administration. The Reagan administration used static tax analysis and
forecast that every dollar of taxes cut would lose a dollar of revenue.
The forecast went wrong for an entirely different reason. The
Keynesian orthodoxy of the time was that it was impossible for the economy to
grow without paying for it with a rising rate of inflation. Yet, the
supply-side position was that by reversing the policy mix, the economy could
grow while the rate of inflation fell, which is in fact what happened during
the 1980s and 1990s.
As economic forecasting was locked into the �Phillips curve� -- the belief that
inflation was the price of full employment, and that unemployment was the price
of lower inflation -- the Reagan administration�s budget forecast was
restrained by the �Phillips curve.�
Orthodoxy would not permit us to forecast the extent to which a supply-side
policy would bring down inflation as the economy grew. Even if we had been able
to disregard forecasting orthodoxy, our forecast would have been off as Volcker
brought money growth in below target.
The �Reagan deficits�
thus resulted from the unanticipated collapse of inflation. As inflation came
in below forecast, nominal GNP came in below forecast. Thus, tax revenues were
less. But appropriation bills are in nominal dollars, which meant that real
spending was greater than intended because inflation was less than forecast.
Wall Street believed that the �Reagan deficits� would cause inflation, but, of course, they did
not cause inflation as they were the consequences of the collapse in inflation.
This shows how totally wrong conventional opinion can be
even when it tries to think. Today, no policy maker or establishment economist
is thinking at all.
The �Reagan deficits�
were neither financed by printing money nor dependent on recycling of surplus
dollars by trading partners. The deficits were no threat to the dollar, which
was thought to be too strong. The increased after-tax return on investment
reduced the flow of US capital abroad, and we financed our own deficit.
This brings us back to the original question: How is the
Obama deficit going to be financed?
Craig Roberts [email
him] was Assistant Secretary of the Treasury during President
Reagan�s first term. He was Associate Editor of the Wall Street Journal. He has
held numerous academic appointments, including the William E. Simon Chair,
Center for Strategic and International Studies, Georgetown University,
and Senior Research Fellow, Hoover Institution, Stanford University. He was
awarded the Legion of Honor by French President Francois Mitterrand. He is the
author of Supply-Side
Revolution : An Insider�s Account of Policymaking in Washington; Alienation
and the Soviet Economy and Meltdown:
Inside the Soviet Economy, and is the co-author with Lawrence M.
Stratton of The
Tyranny of Good Intentions : How Prosecutors and Bureaucrats Are Trampling the
Constitution in the Name of Justice. Click here for
Peter Brimelow�s Forbes Magazine interview with Roberts about the recent
epidemic of prosecutorial misconduct.