President Ronald Reagan's Economic Policies and the Recession
How Reagan Ended the 1980s Recession
Reagan promised the "Reagan Revolution," focusing on reducing government spending, taxes, and regulation. His philosophy was, "Government is not the solution to our problem. Government is the problem."
Reagan was an advocate of laissez-faire economics.
He believed that a free market and capitalism would solve the nation's woes. His policies matched the "greed is good" mood of 1980s America.
Reagan's Early Years
was born on Feb. 6, 1911. He studied economics and sociology at Eureka College in Illinois, then he became a radio sports announcer and an actor, starring and appearing in 53 films. As president of the Screen Actors Guild, he became involved in rooting out Communism in the film industry. That led to him developing more conservative political views. He became a TV host and spokesman for conservatism, then served as Governor of California from 1966 to 1974.
Reagan was nominated as the Republican presidential candidate in 1980. George H.W. Bush was the nominee for vice president. Reagan defeated Jimmy Carter to become the 40th president of the United States.
1980-1981: The Recession
Reagan inherited an economy mired in stagflation, a combination of double-digit economic contraction and double-digit inflation. He aggressively cut income taxes from 70% to 28% for the top tax bracket to combat the recession. He cut the corporate tax rate from 48% to 34%, and he promised to slow the growth of government spending and to deregulate business industries.
At the same time, he encouraged the Federal Reserve to combat inflation by reducing the money supply.
Reaganomics and Tax Cuts
Congress cut the top tax rate from 70% to 50% in 1981. This helped spur growth in gross domestic product for the next several years. The economy grew 4.6% in 1983, 7.3% in 1984, and 4.2% in 1985.
Economic growth reduced unemployment for the next several years. It was 8.5% in December 1981. The minimum wage was $3.35 an hour. Congress passed the Job Training Partnership Act in 1982, establishing job training programs for low-income people. The unemployment rate rose to 10.8% by December 1982, then it fell to 8.3% in 1983, 7.3% in 1984, and 7% by December 1985. Reagan cut the tax rate again, to 38.5% this time, in 1986.
Growth was a healthy 3.5% by the end of 1986, but the unemployment rate was 6.6%. It was still higher than the natural rate of unemployment. Reagan cut taxes again to 28%. Growth bounced up to 4.2% in 1987 and unemployment fell to 5.7%. Growth leveled out at 3.7% in 1988 and unemployment fell to 5.3%.
The Policies of Reaganomics
The increased revenue from a stronger economy is supposed to offset the initial revenue loss from the tax cuts.
But according to the Laffer Curve explanation, this only works if the initial tax rates are high enough. High taxes fall in the curve’s “Prohibitive Range.” Reagan's first tax cuts worked because tax rates were so high, but the 1986 and 1987 tax cuts weren't as effective because tax rates were already reasonable at that time.
Reagan also offset these tax cuts with tax increases elsewhere. He raised Social Security payroll taxes and some excise taxes, and he cut several deductions.
Reagan cut the corporate tax rate from 46% to 40%, but the effect of this break was unclear. He changed the tax treatment of many new investments. The complexity meant that the overall results of his corporate tax changes couldn't be measured.
Reagan and Deregulation
for continuing to eliminate Nixon-era price controls. They constrained the free-market equilibrium that would have prevented inflation. Reagan removed controls on oil and gas, cable television, and long-distance phone service. He further deregulated interstate bus service and ocean shipping.
Reagan deregulated banking in 1982 and Congress passed the Garn-St. Germain Depository Institutions Act. The Act removed restrictions on loan-to-value ratios for savings and loan banks. Reagan's budget cut also reduced regulatory staff at the Federal Home Loan Bank Board. As a result, banks invested in risky real estate ventures. Reagan's deregulation and budget cuts contributed to the savings and loan crisis of 1989. The crisis ushered in the 1990 recession.
Reagan did little to reduce regulations affecting health, safety, and the environment. In fact, he reduced these regulations at a slower pace than the Carter administration did.
Reagan's enthusiasm for the free market did not extend to international trade. Instead, he raised import barriers. Reagan nearly doubled the number of items that were subject to trade restraint from 12% in 1980 to 23% in 1988.
Despite campaigning on a reduced government role, Reagan wasn't as successful with this as he was with tax cuts. He cut domestic programs by $39 billion during his first year, but he increased defense spending to achieve "peace through strength" in his opposition to Communism and the Soviet Union.
He was successful in ending the Cold War. This was when he uttered his famous quote, "." Reagan wound up increasing the defense budget by 35% to accomplish these goals.
He did not reduce other government programs. He expanded Medicare and increased the payroll tax to ensure the solvency of Social Security. Government spending actually increased 2.5% annually under Reagan.
Reagan and the Debt
Reagan's first budget was for fiscal year 1982. As the chart below reveals, he incurred substantial deficits for each year of his presidency. As a result, debt also increased each year. The national debt had more than doubled by the end of Reagan's presidency.
The first column shows the fiscal year, followed by the deficit that year, the U.S. debt in billions, the deficit GDP, and the corresponding historical event.
|1981||$79||$998||2.4%||Reagan tax cut|
|1982||$128||$1,142||3.8%||Reagan's 1st budget|
|1984||$185||$1,572||4.5%||Increased defense spending|
|1987||$150||$2,340||3.1%||Black Monday crash|
|1988||$155||$2,602||2.9%||Fed raised rates|
Reagan captured the mood of voters when he said, "Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hit man." The inflation rate was 12.5% in 1980 and 8.9% in 1981. It fell to 3.8% in 1982. Inflation remained below 5% for the remaining years of Reagan's presidency.
But Reagan can't take all the credit for combating inflation. Federal Reserve Chairman Paul Volcker steadily raised the fed funds rate to 18% in 1980. High-interest rates ended double-digit inflation, but this also triggered the recession.
The Council of Economic Advisers
During his eight-year term, Reagan brought many well-known economists to the Council of Economic Advisers. New chairmen included Murray Weidenbaum, Martin Feldstein, and Beryl Sprinkel. The Council also included William Niskanen, Jerry Jordan, William Poole, Thomas Gale Moore, and Michael Mussa. Niskanen was one of the architects of Reaganomics. The staff included Nobel Prize winner and New York Times columnist Paul Krugman and Harvard professor Larry Summers. Summers later became President Obama's Director of the National Economic Council.