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How Did Reaganomics Alleviate Inflation?

Updated on December 9, 2017
Pendhamma S profile image

Pendhamma Sindhusen is a conservative author on American politics and history and economics

Overview of Reaganomics's tenet

Brief overview graph of interest rate and supply's relationship to inflation rate illustrated by Pendhamma Sindhusen, using Canva infographic maker
Brief overview graph of interest rate and supply's relationship to inflation rate illustrated by Pendhamma Sindhusen, using Canva infographic maker | Source

Introduction

On November 4, 1980, 69 years old former 2 terms California governor, Ronald Reagan was elected as president of the United States in a landslide (biggest for non-incumbent candidate) over incumbent president Jimmy Carter with 44 states voted for him. His utter victory was partially propelled by his campaign promise to end the severe chronic inflation (as part of stagflation) with his Reaganomics, aka Voodoo economics. Upon taking office, Reagan moved swiftly to implement policies premised on it, sharply mitigating inflation through cutting taxes, reducing regulations and ramping up federal interest rate, ultimately curtailing the devastating inflation. This article expounds to you this sophisticated economic tenet, using basic economics essentially on inflation, monetary and fiscal policy and Demand-Supply law, giving you a new savvy of what you may have been misled with comprehensive aspects delved from various aforementioned economics.

Derivations and Quintessence

Reaganomics derived from 2 words, Reagan and economics, ingeniously contrived by radio broadcaster, Paul Harvey. These 2 words are compounded as portmanteau, meaning President Ronald Reagan's economic policy although his 1980 primaries opponent (who later became his VP and his successor in 1988). George H.W. Bush pejoratively called it Voodoo economics. In fact, Reaganomics is the third presidential economic policy to be portmanteau of presidential lastname and economics, following Nixonomics and Carternomics.

In the late 70's, America was stuck in a quagmire of severe stagflation (portmanteau of stagnation and inflation, connoting economic phenomenon affects the economy with stagnation or recession (regressive growth) and inflation simultaneously) caused by Arab oil embargoes of 1973 and 1979 and suddenly oscillated monetary system from representative money to fiat money in 1973. As Reagan determined to run for presidency in 1980 (he actually lost to sitting president Gerald Ford in the GOP primaries in 1976), one most concerning issue for him was the economy, cajoling him into devising an economic policy of his own to combat stagflation. He pledged if elected, he would staunchly tackle with the lousy economy with his "Reaganomics" . His Reaganomics, premised on trickle-down economy or supply-side economics, primarily meant to raise federal interest rate in order to extenuate inflation and stimulate the torpid economy through cutting thrice individual income, corporate and capital gains taxes and with his economic policy, the economy recovered within 2 years and was poised on prosperous and unprecedented economic growth, making Reagan a great epitome for Republican posterity today. To examine further into his economic success, Reaganomics's processes are ramified into latter topics of Monetary policy and Fiscal policy & Deregulations

President Ronald Reagan, proponent of Reaganomics

President Reagan's official portrait, posed at his Oval Office desk. 10/25/84.
President Reagan's official portrait, posed at his Oval Office desk. 10/25/84. | Source
President Reagan addressing the nation of his Reaganomics outline to combat inflation from the Oval Office on July 27, 1981
President Reagan addressing the nation of his Reaganomics outline to combat inflation from the Oval Office on July 27, 1981

Monetary policy

The major monetary policy US government under the Reagan administration orchestrated through the Federal Reserve was to raise federal interest rate as part of Reaganomics in order to mitigate then severe double digit inflation. The move decisively succeeded in reducing inflation. Within 2 years, inflation attenuated from the high of 12 percent to below 4 percent thanks to Federal Reserve chairman Paul Volcker's assertive decision to tremendously raise interest rate to 14 percent, but this move also entailed a devastating recession lasting from 1981 to 1982. In the recession, unemployment quickly soared to 10 percent. But, later, the economy unprecedentedly expanded with more than 15 million new jobs added (17 percent increase) throughout his term.

As we now savvy the Reagan administration's monetary policy aimed to resolve the economic malaise of stagflation, we are to advance to the reason why such policy trounced inflation in order to gain broader and more comprehensive of economics.

According to the extensively accepted Keynesian economics attributed to famed economist John Maynard Keynes, interest rate is in contrast to money supply and liquidity as higher interest rate persuades consumers to deposit their money in the banks or buy government bonds, i.e. to save their money (since they receive more returns), rather than spend their money while simultaneously dissuades investors and entrepreneurs from petitioning loans from the banks (as they ha=ve to reimburse much more than when the rate is low), contracting money supply, i.e. sapping out money from the economy. Contrarily, lower interest rate cajoles entrepreneurs into borrowing money from financial institutions to expand their businesses and discourages consumers from saving, prompting them to accede to their demands of buying commodities with the opposite reasons. This tenet of relationship is presented through the IS-LM model (I = Interest rate, S = Savings, L = Liquidity and M = Money supply). Keynes asserted extravagantly high interest rate poses a great and formidable threat to the economy as well as excessive saving does, with this model. The IS-LM also implies an equilibrium point whose interest rate (compounded with saving) is equilibrated at an optimum rate, capable of maintaining appropriately moderate liquidity and money supply (this point is presented in the model as an intersection of IS and LM line). This model epitomized government's intervention in the economy through monetary policy to tackle with money supply, prompting the Federal Reserve to wield the federal interest rate in times as its tool to manipulate money supply by simply raise it and reduce it in times of inflation and deflation consecutively as we experienced in 1981.

Rough IS-LM model

Brief overview graph of interest rate and supply's relationship to inflation rate illustrated by Pendhamma Sindhusen, using Canva infographic maker
Brief overview graph of interest rate and supply's relationship to inflation rate illustrated by Pendhamma Sindhusen, using Canva infographic maker | Source

Fiscal policy and Deregulations

On the budget issue, the Reagan administration prioritized incentivizing businesses to grow and expand through cutting taxes and reducing regulations in the process of increasing supply and productivity. With more supply, the market became more competitive, pushing down prices. Lower prices, combined with higher savings downright ameliorated the awfully high inflation since it decisively reduced money supply.

In 1981, although with Democratic majority in the house, Reagan managed to convince the congress to pass a tax cut bill, signing in to law the Economic Recovery Tax Act. The act cut the top income tax rate from 70 to 50 percent and the bottom rate from 14 to 11 percent and entitling more economic units to tax deductions and tax exemptions. The act was postulated to trickle down on the economy, but with double-digit interest rate slashing the economy and severely weakened economy, the trickle down was not immediately to resurrect growth. As supposed, the act was to increase the federal revenue, but instead, practically, it decreased the revenue because of the aforementioned still-weak economy. The decrease in federal revenue prompted the congress to pass the Tax Equity and Fiscal Responsibility Act in the later year. The act revoked some of the ERA's mandated tax deduction eligibilities and abrogated some ineffective part of the act as a process of reducing the federal deficit. In 1986, the congress passed the Tax Reform Act, further cutting top income tax rate from 50 percent to 28 percent while issuing a simultaneous bottom rate increase from 11 to 14 percent. The act also consolidated tax brackets from 15 income tier to 4, mandated capital gains tax to be levied at the same rate as income tax and altered some of US tax system, expanding tax deductions and exemptions. This expansion resulted in removal of 6 million destitute Americans from income taxes burden at an instance. These rates seemed to be the most generative in the Laffer curve, rates always been elusive to economists although constantly omitted and denied by liberal politicians. The tax cuts of 1981 and 1986 are combinedly called Reagan tax cuts. They contributed to an era of unprecedented economic prosperity lasted for almost a decade beaten only by President Bill Clinton's economic growth in the 90s.

In the field of deregulation of businesses, the Reagan administration took more sluggish pace than the preceding Carter administration as less regulations were extant. Throughout his tenure as president of the United States, Reagan sharply terminated government's regulation on businesses mostly through executive orders as he saw them as impediments to American freedom and economic growth. The best epitome for this strong belief of Ronald Reagan is his remarks in his first inaugural address "In this present crisis, government is not the solution to our problem, government IS the problem". He lifted up regulations on gas and oil industry, television broadcasting, interstate bus service, ocean shipping and phone telecommunication with dozens of executive orders. In 1982, the congress passed a milestone bill in deregulating banking industry, the Garn - St. Germain Depository Institutions act. The act rescinded New Deal-era loan to value ratios for saving and loan banks although this deregulation is condemned for contributing to the Savings and Loan crisis in 1989. Nevertheless, the deregulation paid off. Businessmen and investors got quickly tantalized to invest in their businesses, increasing market supply. As supply swelled, competitive market acutely resurged, driving prices down and eventually alleviate severe inflation. Reagan also brought free market equilibrium back to the market when he signed an executive order on his tenth day in to office, eliminating Nixon-era wage and price controls decried for messing the economy.

After all, do you approve the Reaganomics ?

Do you approve the Reaganomics ?

See results

Graph depicting Reagan's economic success comparing to other recent US presidents

Job growth under Reagan administration comparing to other recent administrations
Job growth under Reagan administration comparing to other recent administrations | Source

© 2017 Pendhamma S

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