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.


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