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Why You Should Care
Trickle-down economics, while attractive in principle, has still not met with measurable success in over 100 years of trying. When politicians declare that making the rich richer will help everyone, take that with a grain of salt. That said, the supply-side foundation that the “trickle-down” outcome is based on shouldn’t be dismissed as a bad idea.
62. REAGANOMICS
Reaganomics, the phrase coined for the economic policies of the Ronald Reagan 1981–88 presidency, was essentially an implementation of supply-side economics tailored for the times (see #60 Supply-Side Economics). The major premise and promise was an across-the-board reduction in income and capital gains tax rates to bolster an economy recovering from the stagflation hangover of the late 1970s (see #20 Stagflation).
What You Should Know
Ronald Reagan came into power in a particularly tricky economic period—one tricky enough that the traditional doses of monetary medicine would have made problems worse. The bulge in inflation in the late 1970s (see #18 Inflation) was caused by forces beyond monetary policy—that is, the supply shock and price escalation in the energy sector. Worse, inflation had become part of the daily mentality of consumers and business leaders alike; everyone expected it, and so raised prices defensively in advance of it. Inflation was a self-fulfilling prophecy.
The standard money-supply remedies for inflation were clearly not working. The Fed funds rate reached an all-time high in 1980 and led to the recession of 1981–82, but did not do as much to temper inflation or inflationary expectations as one would have hoped (see #21 Interest Rates). The challenge of the Reagan administration was to combat inflation and stimulate growth without relying on traditional monetary policy.
The solution was a hybrid of monetary and supply-side economics. The Fed began lowering interest rates to increase money supply; at the same time, supply-side initiatives of lower taxes and promises of better times spurred production. The increased production then consumed, or “mopped up,” the excess liquidity, or money, pumped into the economy. While more money chasing the same amount of goods and services leads to inflation, more money chasing more goods and services does not.
The Reagan administration, playing its “trickle-down economics” card to justify and pass the programs, used the expression “a rising tide lifts all boats” (see #61 Trickle-Down Economics). The economy rebounded while commodity prices fell at the same time—a rare combination that might be attributed to the combined policy. Detractors maintain that the high interest rates alone (they were declining, but still historically high—see Figure 3.1) brought the fall in commodity prices, but this argument seems out of place, because the economy was indeed rebounding.
Tax revenues—at least nominal, or not inflation-adjusted—grew. They fell as a percent of GDP, but that was intended and expected with lower tax rates. Real tax revenues did not increase, however, until 1987. It should also be noted that while federal income tax rates dropped, FICA taxes for Social Security and Medicare, as well as taxes in many states, increased.
Still, it looks like Reaganomics was indeed a dose of i
Why You Should Care
The Reaganomics experience showed us all that creative approaches to solving economic problems and aiding prosperity can work. One should be concerned about budget deficits, but one should also not be led to think that tax increases are the best way to close budget gaps. The George W. Bush years (2001–2008) look more like reckless tax policy designed to favor the rich without hope of increasing revenues, and deficits increased widely while the seeds of the Great Recession—too much spending on overinflated assets, and a lax view of risk—were sown. The policies of the Obama administration haven’t been able to touch the rich so much as the president himself would have liked, and new spending has dramatically increased deficits, but there is some evidence that tax revenues are increasing even without major tax rate changes, Perhaps in the next edition of this book we’ll be able to say that Reaganomics and supply-side policies really do work, but for right now, the Reaganomics practiced during the Reagan administration appears to be a much more carefully considered experiment.
63. BEHAVIORAL ECONOMICS
What? You’ve got to be kidding. People don’t follow the economic rules? People do things that don’t fit neatly into demand and supply curves? People respond differently to different situations depending on stress, time, and what they see others around them doing?
You bet. And the presence of such “misbehavior” has given rise to a school of economics that combines economics with psychology, behavioral economics. This marriage of two subjects, both hard to research and quantify, has taken center stage in economic thought, as economists and policymakers struggle to fix and avoid economic problems.
What You Should Know
Behavioral economics applies social, cognitive, and emotional factors to better understand economic decisions by consumers, borrowers, and investors, and how they affect market prices and behavior. In short, it applies a human factor to decision making, a dose of “psychological realism.” Behavioral economists try to figure out how and why actual behavior differs from rational and even selfish behavior—that is, the lowest cost, lowest risk, or most profitable course of action.
Interest in behavioral economics has increased as a result of the recent mortgage crisis and real estate bubble. Why did so many unsuspecting citizens take on so much debt, so much risk, and so much cost, assuming all along that the real estate market was foolproof? People have been asking such questions for years, dating back to the tulip bulb mania of the early 1600s. But it happens again and again through history. The answer seems to lie somewhere in the “madness of crowds,” or the tendency for people to assume something is right because everyone else is doing it. Moreover, studies indicate that many people jump into these things because they fear being left out; not investing becomes the irrational decision.
In the fall of 2008, the U.S. economy went from an overdose of risk to complete risk avoidance in a matter of months. We went from lending 100 percent of value to a subprime customer to not lending anything at all.
Policymakers have begun to take such factors into account when making policy decisions—although they obviously have a way to go in truly understanding economic behavior, especially in crisis times.
Why You Should Care
Next time you think about “going along with the crowd,” make sure you’re acting in what economists would call “rational self-interest.” Not all economic or financial decisions can be approached with rigid, mathematical, dollars-and-sense precision; surely your color preference in a car has little to no rational basis. That said, as an individual you are better off for the most part by adhering to economic reality. For society it’s good to know that economists no longer assume that everybody is completely rational; that will lead to less costly policy and to fewer overcorrections in the business and boom-bust cycle. If you want to dig deeper, Dan Ariely’s Predictably Irrational: The Hidden Forces that Shape Our Decisions (Harper Pere