Case Studies
Unemployment on the Rise
 For many years after the Great Depression, the basic
goal of national economic policy was to minimize unemployment. But the winter of 1982 saw 12 million men and women unemployed, and many complained bitterly that they were the victims of a needlessly cruel government policy. This time public enemy number one was inflation and the jobless workers were the casualties in the war.
From Richard Nixon through Jimmy Carter, President after President set out to fight inflation. But when that fight threatened to increase unemployment, President after President reversed course, opting for stimulative policies to keep the economy growing and unemployment low.
When the Federal Reserve began once again to tighten the money supply, workers and businessmen alike refused to believe that the government was serious about ending inflation. Wages and prices continued upwards, growing faster than the money supply. Finally, as unemployment passed10%, the inflation rate began to drop. In August, Fed Chaiirman Paul Volcker announced that the time had come to ease monetary policy. Wall Street was the first to respond. But the bitter memories of the recession lingered on…and faith in counter-cyclical policy was one of the casualties. By 1985, after 2 years of recovery, inflation remained at 4%...but the economy still bore the scars of the recession. Millions of manufacturing jobs were gone for good... and unemployment remained stuck at 7%. Fifteen years of entrenched inflationary expectations had been sharply reduced, but only after the government had finally proven its willingness to pay the price necessary to wring inflation out of the economic system.
| Comment & Analysis by Richard Gill One could argue that the difficult times of the early 1980s were really a reflection of the success of our past policies. The very success of these policies, however, undoubtedly contributed to the recent inflationary tendencies of the economy and, perhaps more significantly, to the expectation of future inflation. By 1980, they had created a general sense that the government would back down in the inflation fight as soon as it began to create serious costs in terms of recession and unemployment. People, in short, began betting on continued inflation. And this made the government’s task infinitely more difficult. The government had to act strongly enough to break the back of these well entrenched inflationary expectations. It not only had to fight inflation, but to fight a general belief that it would not fight inflation that hard. Expectations are important in economics. They made the task of monetary policy much harder in the early 1980s. |
Foreign Trade Effects
 1983 America came bouncing out of the recession with a boisterous recovery. However, out of all those billions of dollars of consumer spending, too much seemed to be pouring overseas. At the same time, foreigners had a high percentage of our national debt. By 1985, economists both here and abroad were asking, "Is our domestic economy the hostage of international forces?" Those international forces had been building throughout the 1970s. During that decade, the percentage of our economy devoted to foreign trade doubled. 1983 was a year of vigorous growth for America as the economic recovery surged ahead. It soon became obvious that many Americans were being left behind. While millions of jobs were being created in the service industries, millions more in manufacturing appeared gone for good…lost to overseas competition. In the 60s and 70s, expansive economic policies had created jobs for American workers. Now these same policies were creating jobs overseas while Americans remained unemployed. The situation was causing severe problems for American policymakers You may want to expand the economy…let us say by budget deficit or easier money…but some of this demand goes abroad.
People buy Japanese cars and so you get expansion in Japan but not in Detroit. For instance, we’ve got a 200-odd billion dollar budget deficit, but half of the money is going abroad and so we’re getting stimulation only from alf. Fiscal policy is losing much of its power."
No one in the Reagan administration had foreseen this effect in 1981 when the administration first embarked on its expansive course…But as our trade deficit shot past the 100 billion dollar mark, economists and politicians alike began to search for a solution. Most economists agreed that the trade deficit was caused by the overly strong American dollar, which was in turn caused by the runaway budget deficit. But many politicians began to argue for trade barriers to keep out the flood of imports. The Reagan administration resisted this approach. Five months after the Bonn summit, the U.S., Japan,
France, Britain and Germany announced a coordinated effort to reduce the value of the U.S. dollar. The move was a promising effort to ease the U.S. international trade dilemma and possibly create more jobs for American workers. But major problems remained. By 1985, the United States was running 200 billion dollar budget deficits. But half the economic stimulus, the amount of the U.S. trade deficit, was going overseas and any effort to contain this deficit or to promote continued growth had a major impact around the world.
Counter-cyclical Policy
 The Employment Act of 1946 created a Council of Economic Advisors to give the president the benefit of the best economic advice. For almost 40 years the essence of this advice was to manipulate the economy to prevent inflation and to promote growth. It was called counter-cyclical policy. But, by 1985, the man who occupied this office was urging a receptive president to keep his hands off. By 1985, the man who held this office sharply rejected the idea that the government could fine tune the economy. Monthly fine-tuning of monetary policy created havoc in the economy, When Paul Volcker initiated a new monetary policy designed to quell inflation once and for all, he made much of the fact that the new policy was on for the duration. No more starts and stops. When Ronald Reagan embarked on the most expansive fiscal policy in history, he locked his policy in place three years in advance. No turning back. 1983 and 1984 were years of growth in the American economy, but, as the economy grew, the budget deficit grew even faster. By 1985, many economists felt that fiscal policy was dead…a casualty of the towering deficit.
In 1985, the sour notes in our economic performance warned that problems of inflation and unemployment were still with us. But the consensus of the economic community was that the most effective response was a
policy of coarse-turning rather than the more active management of an earlier generation.
| Comment & Analysis by Richard Gill Back in the 1950s and 1960s, the Keynesian view was dominant. With slight turns of the rudder of monetary and especially fiscal policy, one could, most economists felt, steer the economic ship past inflation and of unemployment. But today even Neo-Keynesians concede that economic navigation may be less of an exact science than was once imagined. In general, the shift of emphasis from fine-tuning to coarse-tuning has been a shift in time perspective from the short to the longer run. Active intervention in the shortrun, many economists now feel, may only intensify our longer-run problems. Unfortunately, there is no real agreement as to what the truly important long-run factors are. |
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