Politicians & the Economy - Some History

Over the years I have encouraged folks to understand and to think clearly about the economy. One important issue to me is separating the economy from politics - a truly difficult task.

Most voters seem to subscribe to the thesis that the president has a significant impact on the economy. To a large extent this belief has persisted for many years. I believe that it was heightened by the Clinton years in the White House. He made the economy the primary focus of his 1992 campaign and the economy did well during his two terms so it seems natural to believe that he had something significant to do with it. In my opinion, the last time that a President had a significant and long-lasting effect on the economy was when Carter nominated Volker to be Fed Chairman.

Let's try to go back over administrations of the 20th century to quantify what actually happened.

In 1913, during the Wilson administration, the Federal Reserve was created. Financial panic and depressions had been regular occurrences before this. Too much power was in the hands of a handful of powerful businessmen. Theodore Roosevelt understood that and "stood up" to powerful businessmen when their interest and the interest of the public were out of synch.

Unfortunately, during its first decades the Federal Reserve did not know what it was doing. In 1923 Coolidge became president and was dedicated to the concept of laissez-faire which is French for "butting out." In 1924 the stock market became popular and started a spectacular rise. It was like the dot-com thing but on a larger scale. People traded up equities with little basis but greed. From May 1928 to September 1929, the average prices of stocks rose 40 percent. This was despite the fact that many of what we would regard as economic indicators were flashing "red". Folks were making ill-informed investment decision or maybe they were merely being greedy. Greed plus bad information is not a formula for success. It is a great formula for disaster.

In August 1929 a recession began. For the next two months GDP fell at an annualized rate of 20% and personal income fell at an annualized rate of 5%.

The stock market crash started on October 24. The Fed lowered the Fed funds rate from 6% to 4% and added to the money supply during the first few months but then did nothing more until 1932. It essentially stood on the sidelines trusting that the markets were undergoing a normal correction process. The Fed failed to abate the Great Depression in its early stages by not increasing money supply and not drastically lowering interest rates. The Great Depression could have ended much sooner if the Fed understood then what it does now. The Great Depression got worse until 1933. GNP fell 31%, unemployment was almost 24%, equities lost 80% of their value, the money supply was reduced by 31%, there were over 10,000 bank failures.

FDR was elected in 1932. Roosevelt took some drastic actions: he declared a "banking holiday" to stop the run on banks, he increased taxes dramatically. Roosevelt understood that government spending would spur on the economy but refused the Keynesian notion that deficit spending was needed and another recession occurred in 1937-1938.

Starting in 1939 the U.S. economy boomed as the world went to war. The U.S. came out of World War II as the world's only intact economic superpower.

Interestingly, the next big event that stimulated the economy was the Vietnam War. But a Johnson tax cut coupled with war spending led to inflation . That was inherited by Nixon. The Ford and Carter years are regarded as an economic disaster area but the strange fact is that 10,000,000 new jobs came into being during Carter's term. The Ford and Carter administrations had very high inflation. One of the strongly contributory things was the Arab Oil Embargo of 1973.

(It has to be noted here that the Johnson tax cut and war spending are certainly similar to what is happening now. The question is this: is it the case that the Federal Reserve is more adept and can survive this potentially inflationary situation with monetary policy alone? We shall see.)

The tide may have shifted when Carter appointed Volker to be Fed Chairman but few realized it at the time. Reagan ran on a "misery index" platform and unseated Carter. It was not until Reagan's second term that economic recover, under Volker's leadership, started to have a dramatic effect.

In 1991 Bush I suffered a mild recession and got blamed for it. Clinton, reprising what worked for the Reagan campaign, expertly emphasized that the issue was the economy (It's the economy, stupid) and looked great. Like Reagan, Clinton certainly knew how to work the audience. The present Bush's inarticulate manner of speaking is comical as compared to Clinton's very articulate speaking ability or Reagan's down-home, actor inspired connect to the average guy manner.

During the Clinton administration GDP growth averaged 3.5% per year, inflation was tame and unemployment low. Equities had some nasty boom/bust cycles but that was about greed and stupidity on the part of casual players. The president was responsible for neither the booms nor the busts.

Bush II inherited lowering GDP growth and that coupled with the economic shock of 9/11 created a min-recession and impetus for the Bush tax cuts. While those tax cuts were expansionary and achieved strong GDP growth they certainly have increased the deficits and national debt. It is concern about this last issue that were the basis for my suggestions for a new fiscal authority.

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Dick Lepre

Comments

[robkay]

While the post-tax-cut deficit has increased, so have the post-tax-cut tax revenues. Our biggest problem regarding the deficit remains on the spending side. Bridges in Alaska to serve a handful of people; paying able-bodied citizens who do not add value to the economy; overpaying government workers who produce nothing, provide little service, and are not held accountable in their jobs; feel-good programs that enrich only the bureaucrats and their favored few; rampant waste and fraud. Take care of those and other spending issues and we could slash taxes even more, free up capital that would contribute to growth, and still be able to afford to address threats to our safety and security.

[Mike Sacauskis]

Thought your article was excellent. My first thought after reading the paragraph on Johnson, the Vietnam war and Tax cuts was that it sounded a lot like the current administration. Glad you mentioned that. Inflation has always been the after effect of a war. I beleive the same fates that caused rampant inflation in the 70's and early 80's are now conspiring again. The Bush administration does seem to be following the Johnson blueprint whether intentional or unintentional, with the added issue of rising fuel costs.

One way to lower the national debt is to inflate the economy. Inflation is creeping up. If you look over the past 4 years the inflation rate is on an upward trend. While the administration claims the deficits are improving, the cost of the war is not included in the deficit estimates. I don't think we can honestly say what the deficits are because the costs of the war are open ended. The war is not being funded by the general fund, it's being funded with supplementary bills that are not being countered by decreases in spending or additional taxes.

Also, can increased revenues really be attributed to tax cuts? While the U.S economy may be more complex, I would suggest that you try cutting your income and increasing your spending. it's a reciepe for disaster. The only way this strategy works is if inflation is rampant, you're paying for what you bought today with inflated dollars. I don't see how the Fed by raising interest rates is going head off the disaster that this administration is creating. With fuel costs rising as they have, inflation seems to be ready to permeate the economy because it will cost more to transport goods, which will lead to increased prices of goods.

I would also suggest that what's fueled the increase in revenues is the increase in governement spending. As you noted it wasn't until we began to mobilize for WWII did the economy really come out of the great deperession. Haliburton alone has been given corporate welfare in astronomical sums in no-bid contract deals.