We have discussed the basic attributes of both the Classical and Keynesian economic theory, then we looked at how Classical economics performed in America up until the end of WWII, roughly 1945. Even classical economic supporters admit that the classical model did not perform as well as expected during the Great Depression so at that time America switched gears and began using the Keynesian model. I know that since reading the first two breathtaking installments you got excited and researched the issue in depth thus making this third part unnecessary. But I guess I will go ahead and present it anyway.
The Keynesian model worked well in the decades following the war and, in fact, Richard Nixon stated that, “we are all Keynesians now.” During the 1950′s and 1960′s America saw economic growth and low unemployment, thus increasing the popularity of the economic model. But in the 1970′s the Keynesian model ran into rough waters when we experienced the economic evil of “stagflation.” What is stagflation? Basically stagflation is when inflation rates are very high while economic growth is very low. Why is this such a bad problem? Because the methods used in Keynesian economics to battle the high inflation may worsen economic growth and the methods used to battle low economic growth may worsen inflation. So what do you do in this situation? If you have a sound theory please send it in because we really need it.
Stagflation in the 1970′s – Well, there are many theories out there about how this happened but I will present, what I feel, is the most commonly accepted theory. First, after Nixon imposed wage and price controls in 1971, there was a negative economic reaction that caused prices to spiral. Second, we endured the 1973 oil crisis where OPEC constrained the world-wide supply of oil. This, in addition to, a general energy shortage anyway caused shortages in raw materials. Jimmy Carter made some incorrect economic decisions in dealing with this and made matters worse. This economic crisis led many people to doubt Keynesian methods and there was a rise in neo-classical thought. I will stop here with the explanation because it gets more convoluted and is simply not necessary to make my point. The bottom line is that stagflation is horrific on an economy and extraordinarily difficult to recover from, thus making it the ultimate issue in politics at the time.
In the 1970′s when the economy was down and people were on the verge of giving up hope, much like I am with our current Congress, there came a prophet with a new plan. That prophet was Ronald Reagan and his message was “Supply-Side Economics,” well at least a version of it. The concept was to lower tax rates for those in the “upper brackets” and cut capital gains taxes thus motivating investment. It worked and it also didn’t work. While the economy improved the amount of tax revenues decreased thus causing major deficits. Although Congress did raise taxes back up some a couple of years into Reagan’s term the spending never stopped and the national debt was tripled. So Reaganomics lost favor going into the 1990′s and a neo-Keynesian model became popular. This new and improved Keynesian model has been used since then by both Bush’s, Clinton, and Obama.
Numbers from 1945 to 2001: There were a total of 6 recessions during this time period and we saw a combination of Keynesian and Supply-Side economics used. The average length of these recessions was 10 months and the average time between them was 57 months. I will end this installment here so that you can soak up and bask in all the economic data. In the 4th and final installment I will show a comparison between recessions before 1945 (classical economics) and those since 1945 (mostly Keynesian economics).
