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Part 4: Macroeconomic Applications
Chapter 13
U.S. Economic History
The Zero’s and the Teens
The first two decades had some important economic events. First was the
Financial Panic of 1907, followed by the creation of the Federal Reserve System and the
income tax. World War I of 1917-19 closed the teens.
The Roaring Twenties
The best economic decade for the U.S. economy was from 1920 to 1929 which
was called the roaring twenties. After World War, I Americans had a pent-up demand for
goods and services. Pent-up demand is an unsatisfied demand that builds over time. The
type of demand that was created is called Primary Demand or first time purchases. This
caused the Aggregate Demand to increase. New industries were also developed during
the twenties. These included automobiles, oil and gas, radio, electricity, roads, film,
construction and telephone. New industries caused the Aggregate Supply to shift
outward. The increases in Aggregate Demand and Supply created an Expansionary gap.
The Thirties
The worst economic decade for the U. S. was the 1930s also known as the Great
Depression. This decrease in Aggregate Demand was caused by the high level of credit, a
delay in Secondary Demand (replacement purchases), the stock market crash of 1929, the
near banking system collapse and increased interest rates. British economist John M.
Keynes, the father of macroeconomics had written a book in 1936 called the General
Theory that explained a remedy for a Contractionary gap such as the Great Depression.
Increased government spending for Roosevelt’s the New Deal (government spending for
project in the poor regions of the country) and World War II took the U.S. out of the
Great Depression.
The Forties and Fifties
World War II’s increase in government spending caused an increase in the
Aggregate Demand during the 1940s as did the Korean War in the early 1950s. As with
the twenties there was a pent up demand. The development of new industries such as
highways, air travel, computers, hotels and motels and television increased the Aggregate
Supply. These to factors led to an Expansionary gap during the 20 year time period.
The Sixties
A slight Contractionary gap in the late fifties and early sixties led President
Kennedy (the first president to understand and use macroeconomic theory) to initiate a
tax cut. This along with the U.S.’s early involvement in Vietnam (an increase in
government spending) increased the Aggregate Demand causing an Expansionary gap.
Kennedy, wary of possible inflation instituted wage and price guidelines as a correction
measure. President Johnson escalation of the Vietnam War and his “Great Society”
reinforced the Expansionary Gap. A British economist, A.W. Phillips, discovered a
tradeoff between the unemployment rate and the inflation rate. This became known as the
Phillip's Curve (SRPC or Short Run Phillips Curve).
As the decade ended unemployment had declined and inflation increased. This increased
inflation rate caused by an increase in the Aggregate Demand is known as Demand Pull
inflation.
The Seventies
The economy of the 1970’s was known as Stagflation which was a period of high
unemployment and inflation. This occurred due to decreasing Aggregate Supply and a
Contractionary Gap. Supply Shocks (things which we have no control) took place in the
seventies such as OPEC’s oil embargo, drought caused crop failure, union wage
increases, increased regulations and business taxes. These things caused the cost of doing
business to increase leading to both inflation and unemployment. It was discovered that
the Short Run Phillips Curve of the sixties was not stable and led to the idea of a Long
Run Phillips Curve(LRPC) that is vertical at the potential GDP (full employment).
During this time our three presidents tried different things with little success. President
Nixon tried a wage and price freeze. President Ford wanted the country to wear WIN
Buttons (WIN stands for Whip Inflation Now). President Carter instituted a tax based
incomes policy (firms that followed the guidelines got a tax cut, others a tax increase) and
began what became known as Supply Side Economics with the deregulation of the
transportation industry.
The Eighties
President Reagan instituted Supply Side Economics which became known as
Reaganomics in the early eighties. The policy was based on deregulation, business tax
cuts, reducing union power and reducing personal taxes to stimulate productivity. This
last concept was developed by Arthur Laffer, the father of Supply Side Economics, and
became known as the Laffer Curve.
However, poor timing led to the most severe recession (a Contractionary gap caused by a
decrease in the Aggregate Demand) in the U.S. since the Great Depression. President
Reagan reduced government spending (increasing unemployment) and then gave the
country a tax cut to and unemployed economy. The FED raised interest rates in 1982 and
Reagan increased taxes. The last four years of the Reagan presidency returned to demand
management and was more successful, increasing the Aggregate Demand and creating an
Expansionary gap. However, the deficits of the eight years of the Reagan presidency
were greater than the combined budgets of all the previous presidents.
The Nineties
President Bush I faced a Contractionary gap in the early 1990s caused by a
decrease in the Aggregate Demand. The country was engaged in the Gulf War raising
government spending. The FED lowered interest rates. President Bush I, however, went
back on his campaign promise of “no new taxes” and raised the old ones. He also had a
policy developed during the Reagan years of midnight basketball. The deficits continued
to grow. President Clinton was in the right place at the right time. An Expansionary gap
caused by an increase in the Aggregate Supply. This longest peace time expansion in the
U.S. of decreasing unemployment and inflation was caused by the advent of the New
Economy or Information Age. This was caused by the increased use of personal
computers and the internet, as well as NAFTA, reduced the costs of doing business due to
increasing returns. President Clinton reduced government spending, raised taxes and
created the first surplus budget in 27 years.
The Zeros
The zeros began with a Contractionary gap caused by a decrease in the Aggregate
Demand. President Bush II gave the country a tax cut and engaged in increased
government spending for the War on Terrorism. Huge deficits began to emerge. The Fed
initially lowered interest rates and then began to raise them.
Famous Economist
John M. Keynes: Father of Macroeconomics and wrote the General
Theory (1936)
Arthur Laffer: Father of Supply Side Economics