On Ronald Reagan
INTERVIEWER: Tell us briefly how Paul Volcker set out to squeeze inflation out of the economy.
MILTON FRIEDMAN: Well, by the time Paul Volcker came along -- this was in 1968-69 [Volcker was undersecretary in the Treasury Department from 1969-74, president of the New York Federal Reseve Bank from 1975-79, and appointed chairman of the Board of Governors of the Federal Reserve Board from 1979-87] -- inflation had gotten very high and had gone up close to 20 percent. He was at a meeting of the International Monetary Fund in Yugoslavia in 1979, when the U.S. came under great criticism from the other people there for our inflationary policies. And he came back to the United States and had got the open market committee to announce that they would change their policy and shift from controlling interest rates to controlling the quantity of money. Now, this was mostly verbal rhetoric. What he really wanted to do was to have the interest rate go up very high, to reflect the amount of inflation. But he could do it better by professing that he wasn't controlling it and that he was controlling the quantity of money, and the right policy at that time was to limit what was happening to the quantity of money, and that meant the interest rate shot way up. This is a complex story. It isn't all one way, because in early 1980 President Carter introduced controls on installment spending, and that caused a very sharp collapse in the credit market and caused a very sharp downward spiral in the economy. To counter that, the Federal Reserve increased the money supply very rapidly. In the five months before the 1980 election, the money supply went up more rapidly than in any other five-month period in the postwar era. Immediately after him, Reagan was elected, and the money supply started going down. So that was a very political reaction during that period.
INTERVIEWER: How important was President Reagan's support for Volcker's policies?
MILTON FRIEDMAN: Enormously important. There is no other president in the postwar period who would have stood by without trying to interfere, to intervene with the Federal Reserve. The situation was this: The only way you could get the inflation down was by having monetary contraction. There was no way you could do that without having a temporary recession. The great error in the earlier period had been that whenever there was a little contraction there was a tendency to expand the money supply rapidly in order to avoid unemployment. That stop-and-go policy was really what bedeviled the Fed during the '60s and '70s. That was the situation in 1980, in '81 in particular. After Reagan came into office, the Fed did step on the money supply, did hold down its growth, and that did lead to a recession. At that point every other president would have immediately come in and tried to get the Federal Reserve to expand. Reagan knew what was happening. He understood very well that the only way he could get inflation down was by accepting a temporary recession, and he supported Volcker and did not try to intervene. Now, you know, there is a myth that Reagan was somehow simpleminded and didn't understand these things. That's a bunch of nonsense. He understood this issue very well. And I know -- I can speak with, I think, authority on this -- that he realized what he was doing, and he knew very well that he was risking his political standing in order to achieve a basic economic objective. And, as you know, his poll ratings went way down in 1982, and then, when the inflation seemed to be broken enough, the Fed reversed policy, started to expand the money supply, the economy recovered, and along with it, Reagan's poll ratings went back up.
INTERVIEWER: And the economy has been pretty solid ever since. [As of the year 2000.]
MILTON FRIEDMAN: Yes, absolutely. There is no doubt in my mind that that action of Reagan, plus his emphasis on lowering tax rates, plus his emphasis on deregulating ... I mentioned that the regulations had doubled, the number of pages in the Federal Register had doubled, during the Nixon regime; they almost halved during the Reagan regime. So those actions of Reagan unleashed the basic constructive forces of the free market and from 1983 on, it's been almost entirely up.
INTERVIEWER: What Reagan was doing is almost exactly mirrored in Britain by what Mrs. Thatcher was doing at about the same time. Are the two influencing to each other, or is it just a case of ideas coming into their own?
MILTON FRIEDMAN: Both of them faced similar situations. And both of them, fortunately, had exposure to similar ideas. And they reinforced one another. Each saw the success of the other. I think that the coincidence of Thatcher and Reagan having been in office at the same time was enormously important for the public acceptance, worldwide, of a different approach to economic and monetary policy.
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Reaganomics
Excerpt from Commanding Heights by Daniel Yergin and Joseph Stanislaw, 1998 ed., pp. 341-342.
Essay
It took three years. By the summer of 1982, the conquest of inflation was in sight. In fact, inflation that year would fall below 4 percent. [The] singular achievement [of Federal Reserve Chairman, Paul Volcker] was to conquer inflation at a time when defeatism was rampant. He set the United States on a new economic course. The risks of not succeeding were often on his mind. So was history. Once confronted with the accusation that he was behaving like a German central banker, he replied, "I don't take that as criticism. That's a compliment. I'm in pretty good company there."
Thanks to Volcker's efforts, monetary restraint was obtained quite early in the course of the Reagan administration. And Reagan's unwavering stance in the air traffic controllers' strike of 1981 helped change the tone of labor relations, indirectly contributing to the muting of inflationary psychology. But there was still fiscal policy to be dealt with -- the ways that government raised its revenues and the ways that it chose to spend them. The rise of welfare demands, entitlements, and obligations toward the middle class, the poor, and especially the elderly made spending politically necessary as a source of votes. The problem, of course, was how to finance the outlays.
Ronald Reagan's advisors came to office with the intention of cutting both taxes and spending. But they soon found out that it was easier to achieve the first of these objectives than the second. The reason was simple: politics. It was popular to cut taxes. And taxes did come down substantially. The top marginal rate was reduced from 70 percent to 28 percent; the tax base was broadened; and many deductions and loopholes were eliminated. But it was unpopular to cut spending, and the Democratic Congress bridled at the extent of the cuts that the president proposed. Reagan did not take on middle-class entitlements. He also spared the Defense Department from the ax, and indeed initiated, over the course of his two terms, major increases in defense expenditures, including the "Star Wars" space defense program.
Some in the Reagan camp were optimistic, despite the failure to cut total government spending. They were the advocates of what traditional Republican economist Herbert Stein -- echoing the music of the day -- called "punk" supply-side economics, which made sweeping assertions that reductions in tax revenues resulting from tax cuts would be more than made Up for by higher tax revenues generated by economic growth. It did not turn out that way. Because spending did not come down with taxes -- and indeed defense spending went up sharply -- and because the tax cuts did not feed back into the economy to the extent hoped, both the federal debt and the annual deficit ballooned; and in 1981-82, the economy was in a deep recession.
In September 1982, in its first effort to repair the damage, the Reagan administration followed the "largest tax cut in history" with the "largest tax increase in history." But there was no catching up. By the end of Reagan's first term, the supply-side logic was discredited in the eyes of many, and the inability to bring taxes and spending down together stood in marked contrast to Volcker's victory over inflation. David Stockman, Reagan's first director of the Office of Management and Budget, left the administration dejected, disillusioned with supply-side economics, and chastened by the realities of the political process. Failure to achieve fiscal-policy change, he argued, was a clear vindication of the "triumph of politics" -- of entitlements over austerity, and of the enduring pork-barrel tradition of American legislation over any cold economic logic. "I joined the Reagan Revolution as a radical ideologue," he wrote. "I learned the traumatic lesson that no such revolution is possible."
The triumph of politics and what Stockman called the "fiscal error" that went with it spawned a new monster, which would come to occupy center stage in policy debate: the deficit and the federal debt. Between the beginning and the end of the Reagan presidency, the annual deficit almost tripled. So did the gross national debt -- from $995 billion to $2.9 trillion. Or, as Reagan and Bush administration official Richard Darman put it, "In the Reagan years, more federal debt was added than in the entire prior history of the United States."
There simply was no quick cure to the scale of spending. In the minds of some, however, there was another logic to tax cuts: Reduce taxes and government revenue, and eventually the pain and scale of deficits -- and the threat of national bankruptcy -- would force a retrenchment of government spending. That thought was not restricted to fervent supply-siders, and ultimately it would end up true. But not for some years, and certainly not during the Reagan years.
When George Bush took office in 1989, the annual deficit stood at $152 billion. Taxes could not be raised substantially for devastatingly powerful political reasons -- as Bush found out when his retreat from his solemn "read my lips" campaign promise of "no new taxes" became his most damaging political liability. There was no choice but to contain spending. And luckily, international events afforded a good opportunity to start tackling the problem. The fall of the Berlin Wall and the crumbling of the Soviet empire made possible a tapering-off in defense spending. Still, this was not enough. Owing to the recession of the early 1990s, tax revenues fell, and in 1992, as Bush was ending his term, the deficit peaked at $290 billion. |
