Ronald Reagan's Accidental Keynesian Stimulus: Echoes

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By Joseph J. Thorndike

A spate of bad economic news has revived fears of a "double-dip" recession. Since the Great Depression, such a calamity has only occurred once, when the country suffered through a short and shallow recession in 1980, followed by a long and severe one in 1981-1982.

Traditionally, these twin recessions have been laid at the feet of Paul Volcker, then chairman of the Federal Reserve and now an adviser to President Barack Obama. In particular, the Fed's relentless series of interest-rate increases are blamed for bringing the economy to its knees.

More recently, a few analysts have suggested that fiscal policy might have played a role, too. "What Reagan did was he postponed tax cuts, which I believe caused the deep recession of 1981-82," Arthur Laffer, an economist and fund manager, said on Fox News's "Fox and Friends" program last year.

Laffer is certainly right that President Ronald Reagan's tax cuts were back-loaded. Congress enacted the Economic Recovery Tax Act in 1981, but many of its key provisions -- including a three-stage cut to marginal income-tax rates totaling 23 percentage points -- took effect gradually. Only in 1983 did the act really begin to kick in, at which point the economy "took off like a rocket," Laffer has said.

He is probably right that Reagan's 1981 tax cuts helped jump-start the economy when they finally took effect. But the real "cure" for Volcker's recession came not from Reagan, but from Volcker himself, as the Fed began to reverse its rate increases. The Congressional Budget Office came to that conclusion as early as 1983, suggesting that "lower interest rates after mid-1982 permitted the recovery to begin."

Laffer's claims for the delayed effect -- but ultimate efficacy -- of the Reagan tax cuts come with an interesting postscript. Laffer and his fellow supply-siders have long treated the 1981 act as their crowning achievement. But for analysts of a Keynesian bent, the tax cut -- combined with higher defense spending -- vindicated traditional demand-side policy nostrums.

"The recession resulted from a combination of stringent monetary and fiscal action, but the recovery and boom resulted from Keynesian, rather than supply-side, forces," Wallace C. Peterson and Paul S. Estenson wrote in a 1985 article for the Journal of Post Keynesian Economics.

By cutting taxes and sharply increasing government spending, they explain, Reaganomics "took advantage of a simple but empirically valid principle, namely, that government deficits stimulate economic activity.”

Revenue fell steeply, from 19.6 percent of gross domestic product in 1981 to 17.5 percent in 1983. Spending, meanwhile, rose from 22.2 percent of GDP to 23.5 percent, causing deficits to more than double. By fiscal 1983, the budget deficit had swollen to 6.0 percent of GDP, compared with 2.6 percent in 1981.

The combination of lower taxes and higher spending boosted aggregate demand, spurring the economy during its darkest days.

But today's Keynesians should be cautious in using the Reagan tax cuts to argue for active, countercyclical manipulation of fiscal policy. Political and practical hurdles remain daunting, as does the difficulty of getting the timing right. As Michael Mussa, an economics adviser to Reagan, later recalled: "If the Reagan administration's fiscal policy was helpful from a Keynesian macroeconomic perspective, this should probably be regarded as a fortunate accident."

(Joseph J. Thorndike is the director of the Tax History Project at Tax Analysts and a visiting scholar in history at the University of Virginia. The opinions expressed are his own.)

To contact the author of this blog post: Joseph J. Thorndike at

To contact the editor responsible for this post: Timothy Lavin at


-0- Jun/21/2011 17:29 GMT