Steve Antler Needs a Better Tutor than Stephen Moore

Unless there is some new math that really does say 1.08 divided by 131 equals 6%, Max Sawicky is having fun with Steve Antler. But his On Reaganomics and Supply-side is truly sad as he simply accepts the latest spin from the op-ed pages of the Wall Street Journal as evidence as to the following issue:

the proof lies wrapped up in the whole complicated question of how aggregate costs relate to output – and how taxes, laws (especially those related to property rights), and natural factors like weather and nonrenewable resource price movements, all impinge on the cost/output relationship. Let’s make it simple: supply side economics isn’t simply about whether tax cuts generate their own revenue fixes, but rather whether diminutions of central government’s role in the economy are matched (or even more-than-matched) by increases in private sector activity.

I’m scratching my head as to what this passage means especially since the growth rate of potential output slowed (more on this later) and government purchases as a share of output did not decline during Reagan’s administration.

Let’s also see what passages from the WSJ op-ed caught Steve Antler’s fancy:

When Reagan proposed his 30% across-the-board tax-rate cut, his critics howled that this would cause demand to rise and lead to hyper-inflation. In fact, supply rose faster than demand … the moment the final leg of the tax cut took effect, in January of 1983, the economy roared to life with an expansion that lasted more than seven years … When the budget deficit rose in the mid-1980s, the liberals warned that if Reagan would not raise taxes interest rates would skyrocket. He didn’t and rates didn’t.

Such a masterpiece of odd terminology and weird timing! First a couple of comments on timing. Real interest rates did not skyrocket during the mid or late 1980’s as they had already risen to approximately 7% during the early 1980’s (the nominal interest rate on 10-year Federal bonds in 1983 average just over 11%, while inflation was around 4%). As far as the “final leg” taking effect in 1983, I wonder if Stephen Moore is aware of the Ando-Modigliani lice-cycle model of consumption, which was used by Glenn Hubbard to defend the phased-in nature of the 2001 tax cut. Simply put – the Kemp-Roth tax cut and the 2001 tax cut were sold as phased-in permanent tax reductions, which were supposed to boost consumption immediately. And it turns out that the consumption to GDP ratio did rise early on in both cases.

On terminology, I suspect most classical or market-clearing economists would argue that quantity supplied and quantity demand move together so to say supply rose faster than demand is pure gibberish. But I’m a Keynesian who would argue that potential output in late 1982 (supply) far exceeded actual output (demand) so Moore has this exactly backwards – aggregate demand rose faster than potential output over the rest of the decade. One simply way to capture the change in potential output over the Reagan-Bush41 era is to look at the growth from January 1, 1981 to December 31, 1992 as the economy Reagan inherited and the economy Clinton inherited were essentially the same in terms of the business cycle. Whereas real GDP grew at an average annual rate of 3.5% for the second half of the twentieth century (Moore should know this as his free lunch supply-side colleague Lawrence Kudlow often notes this), average real GDP growth over the Reagan-Bush41 era was only 3.0%.

The real story of the 1980’s was that the Federal Reserve reacting (perhaps overreacting) to the Kemp-Roth tax cut by Volcker’s second dose of tight monetary policy. While the FED’s response succeeded in reducing inflation, its dramatic reaction led to the 1982 recession and the FED’s subsequent easing of tight monetary policy allowed aggregate demand to eventually catch up with potential output. Of course, classical economists at the time preferred to look at the long-run implications of this fiscal-monetary mix noting that the reduction in national savings would lead to less investment and slower long-term growth.

So as the Wall Street Journal wishes to praise Ronald Reagan on the twenty-fifth anniversary of his inauguration, I find it odd that we are reminded of Reagan’s greatest economic failure. After all, candidate Reagan displayed more economic insight in his short passage “work, save, and invest” than Stephen Moore has displayed in all of his various attempts at writing on economics. Alas, President Reagan’s actual fiscal policy undermined his hopes – something almost every economist realizes – but not Mr. Moore. But then Mr. Moore writes:

Perhaps the greatest tribute to the success of Reaganomics is that, over the course of the past 276 months, the U.S. economy has been in recession for only 15. That is to say, 94% of the time the U.S. economy has been creating jobs (43 million in all) and wealth ($30 trillion).

Excuse me but this passage gives too much credit to fiscal policy and too little credit to the Federal Reserve. Perhaps Steve Antler and Stephen Moore should read William Poole’s “Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model” (Quarterly Journal of Economics, 1970). In the standard Keynesian model, lower tax rates do not reduce aggregate demand volatility – especially when politicians keep changing the course of fiscal policy from one Administration to the next. Poole, however, pointed out that the FED could mitigate aggregate demand shocks – a lesson that the Volcker and Greenspan FEDs paid attention to.

I’m also been scratching my head to see if there is a good macroeconomic text that both recognizes the a reduction in national savings (as in George W. Bush’s excuse for tax cuts “give people their money back so they can consume more”) lowers long-term growth and was written by a conservative – and I suspect one by Greg Mankiw should go to the top of Steve’s reading pile.