Time for a Change

The economic recovery now under way appears to have increasing strength and momentum. The stock market has moved up dramatically, interest rates have come down significantly, consumer spending is up, inflation is down, production is growing. That is welcome news to everyone. There are two possible explanations for this recovery. One is that supply-side economics works and that the Reagan tax and budget programs enacted in 1981, together with monetarism, are producing long-term economic growth with low inflation and high investment. The other is that we are experiencing a normal, or slightly subnormal, cyclical rebound after a steep recession, stimulated by consumer spending, high deficits, and easy money—in short, a classical Keynesian recovery.

Of the two explanations, the second one appears to me closer to the mark. Last summer monetarism, coupled with the deficits created by the 1981 budget program, produced the steepest recession since World War II, with the highest real interest and unemployment rates, and almost bankrupted the world. When some of our largest companies and credit institutions, followed by Mexico and Brazil, went to the edge of bankruptcy, the Federal Reserve reversed its tight monetary policy, lowered interest rates, and increased the money supply significantly. This reversal, helped by last summer’s tax package, permitted the present recovery to take hold. Inflation has been brought down dramatically by a worldwide contraction caused by economic austerity, by the creation of 35 million unemployed in the industrial world, by the sharp reduction in oil prices as a result of reduced consumption, and by lower food prices as a result of good harvests and good weather.

The boom in the stock market was set off by lower interest rates driving funds from money-market accounts into equities, as well as by huge inflows of foreign capital from investors who looked to the dollar for political insurance and to our economy as the only safe haven. It was at least partly this inflow of foreign capital that permitted our deficit to be financed while a minimum number of borrowers were crowded out, and interest rates were significantly reduced.

Given the depth of the recession and the stimulus provided by a $200 billion deficit and easier money, a recovery had to happen. It is consumer led, deficit financed, and classically Keynesian in character. It is also pushed along by the stock market. The boom in the market has increased market values by over $600 billion since last summer. Business Week cites a rule of thumb that 6 percent of increased market values is translated into consumer spending. This alone amounts to almost $40 billion. The stock market boom has also brought with it vast speculative excesses that make the 1960s look tame, and that should be viewed with serious concern.

This is not to deny the real achievements of the Reagan administration. By the end of the last administration, we were headed for an inflationary disaster. Partly as a result of its own failures and partly as a result of forces beyond …

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