Parents Parents are now gettingare now getting questions questions like this from their children.like this from their children.

Dad, Do we believe in Supply-sideSupply-side, VoodooVoodoo, DoodooDoodoo, Trickle-downTrickle-down or Girlie MenGirlie Men economics?

Supply-sideSupply-side EconomicsEconomics

VoodooVoodooEconomicsEconomics

DoodooDoodooEconomicsEconomics

Balanced -BudgetBalanced -BudgetEconomicsEconomics

Girlie MenGirlie MenEconomicsEconomics

THE INFLATION-UNEMPLOYMENTRELATIONSHIP

• Normally, there is a short-run trade-off between the rate of inflation and the the rate of unemployment.

• Aggregate supply shocks can cause both higher rates of inflation and higher rates of unemployment.

• There is no significant trade-off over long periods of time.

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Effect of Effect of Changes in ADChanges in AD on Real Output and Price Level on Real Output and Price Level

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Real Real domesticdomestic output output

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EEffectffect of of CChangeshanges in in AD on Real Output AD on Real Output andand P Price rice LLevelevel

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EFFECT EFFECT OF OF CHANGES CHANGES IN IN AD AD ON ON REAL OUTPUT REAL OUTPUT & PRICE LEVEL& PRICE LEVEL

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Effect of Changes in AD on Real Output and Price LevelEffect of Changes in AD on Real Output and Price Level [[Good News-Bad NewsGood News-Bad News]]

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As inflation declinesinflation declines...

THE PHILLIPS CURVE CONCEPTTHE PHILLIPS CURVE CONCEPT

UnemploymentUnemploymentincreasesincreases

The Phillips Curve Trade-OffThe Phillips Curve Trade-Off

UNEMPLOYMENT RATEUNEMPLOYMENT RATE

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A Phillips Curve trade-off betweenA Phillips Curve trade-off between unemploymentunemployment and and inflationinflation..

REAL OUTPUTREAL OUTPUT

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Increases in AD causes . . . Increases in AD causes . . .

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PLPL Y/Empl.Y/Empl.

Shifting Phillips CurveShifting Phillips Curve

Output & EmploymentOutput & Employment UnemploymentUnemployment

StagStagflationflationShifts in ASShifts in AS

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Cause shifts Cause shifts in thein the PC PC

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The unemployment-inflation experienceunemployment-inflation experience of the 1970s & 1980s demolished the idea of an always-stable Phillips Curvedemolished the idea of an always-stable Phillips Curve.

The Phillips Curve Trade-OffThe Phillips Curve Trade-Off

UNEMPLOY. RATEUNEMPLOY. RATE

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A Phillips Curve trade-off betweenA Phillips Curve trade-off between unemploymentunemployment and and inflationinflation..

REAL GDPREAL GDP

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Increases in AD causes . . . Increases in AD causes . . .

ADAD11

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C to B would be like AD1 to AD2C to B would be like AD1 to AD2C to A like AD1 to AD3C to A like AD1 to AD3

C to D like AD3 to AD2C to D like AD3 to AD2

C to E like AD3 to AD1C to E like AD3 to AD1

PL3PL3PL2PL2PL1PL1

Inverted Phillips Curve [“Swerve]Inverted Phillips Curve [“Swerve] ”[late 90s]”[late 90s]

The Crocodile HunterCrocodile Hunter the Fed Still Listens ToAlban William Housego PhillipsAlban William Housego Phillips was a violinist, crocodile hunter,and electrician who became a W.W.II hero. Many say the link between unemployment and inflation has been weakened by technology-driven productivity advancesand global competition. [the so-called “new economynew economy”]However, Alan GreenspanAlan Greenspan still believes in the SRPC trade-off.

97979898

The new economy was reallyThe new economy was reallyjust a favorable supply shockjust a favorable supply shock

[oil dropping from $26 to $11][oil dropping from $26 to $11]and and a speedup in productivity.a speedup in productivity.

Phillips Curve in the 1960sPhillips Curve in the 1960s

Phillips Curve Shifting in the 70s and 80sPhillips Curve Shifting in the 70s and 80s

Phillips “Curl”Phillips “Curl”

UnemploymentUnemployment got worse but so did inflationinflation..

Incomes PoliciesIncomes Policies – Wage and Price Controls

Wage & price controls were tried & failed during these periodsWage & price controls were tried & failed during these periods.Diocletion-301; Kublai Khan-13th century; Antwerp-1584;Continental Congress-1775; Nixon-1971; & S. American Countries-1980s.

Inflation always won and wage and price controls lost.Inflation always won and wage and price controls lost.1. This produces shortages of products & workers can’t send signals.2. Price increases show up off the books.3. Firms convert illegal wage increases (create new job classificationscreate new job classifications) into legal promotions4. Workers can’t freely bargain for wagescan’t freely bargain for wages5. The public quickly tires of thispublic quickly tires of this.6. The Market can’t equate QD and QScan’t equate QD and QS.7. Economists reject this approach to reducing inflation.

Kublai KhanKublai Khan

InflationInflation--UnemploymentUnemployment RelationshipRelationship

• Normally, there is a short-run trade-offshort-run trade-off between the rate of inflationrate of inflation and the the rate of unemploymentrate of unemployment.

• AS shocks can cause both higher rates of inflationhigher rates of inflation & higher rates of unemploymenthigher rates of unemployment.

• There is no significant trade-offno significant trade-off over over long long periods of timeperiods of time.

Wage-Price Controls To Control InflationWage-Price Controls To Control Inflation[1971 & 1973 – both failed][1971 & 1973 – both failed]

President Nixon came into office as a strong opponent ofstrong opponent ofwage-price controlswage-price controls to to control inflationcontrol inflation. However as inflationedged over 5% in summer of 19711971, he did try it for 90 days90 days.

In August of 71, Nixon announced to the nation on a Sunday night (pre-empting “Bonanza”)“Bonanza”), the 90 day freeze on wages. Nixon hoped he would not be perceived as a flip-flopperflip-flopper on this issue. The next day, 90% of thenext day’s news were devoted to this issue. The DOWDOW liked the news andshot up 33 points33 points, as Nixon was perceived as “acting boldly”“acting boldly”, and coming to the defense defense of the consumers against the of the consumers against the “price gougers” “price gougers”. He also did it again in 73again in 73 but it didn’t workdidn’t work any better. His head of the OMB told him that they had convinced the public of their original position that, “wage &“wage & price controlsprice controls don’t work todon’t work to control inflation.” control inflation.”

PProtesters rotesters against against thethe

NNixonixon Wage f Wage freezereeze

So-do wageSo-do wage & & pprice rice ccontrolsontrolswork to control inflation?work to control inflation?

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THE LAFFER CURVETHE LAFFER CURVE

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ReaganomicsReaganomics

The core core of theof the supply-side supply-side theory was that lower marginal taxlower marginal tax ratesrates would cause people to “supply” more labor“supply” more labor, working more and harder, which would increase growthincrease growth – and the positive effect ongrowth would be so large that “G” tax revenue would actually“G” tax revenue would actually increaseincrease rather than decrease in response to the tax cut.

[Ave. 23% cut]

“I was on the Laffer curve.”

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President Reagan said he was on the Laffer curve. He said that after WWII, when he started making big money, that he could do 4 movies before hittingthe top marginal tax rate of 90%. After 4, because he could only keep 10%,he would quit making movies until the next year.

““Yes, I was on the Laffer Yes, I was on the Laffer cuve. I cuve. I couldn’t couldn’t shoot my shoot my way out”way out”

The “Gipper”The “Gipper”BonzoBonzo

For rich peoplerich people, there would be a disincentive to quitdisincentive to quit workingworking when they hit the top marginal tax rate. For most workersmost workers, this was not the casenot the case.

RReaganeagan

Comparing the Laffer Curve to Robin HoodComparing the Laffer Curve to Robin Hood

Arthur LafferArthur Laffer illustrated his supply-side viewssupply-side views with a story relating toRobin HoodRobin Hood, who stole from the rich to give to the poorstole from the rich to give to the poor. Laffer likenedpeople traveling through likenedpeople traveling through Sherwood Forest to taxpayersSherwood Forest to taxpayers, whereas Robin Hood and his band of merry men his band of merry men were governmentwere government. As taxpayers passed through the forest, Robin Hood and his men intercepted them and forced them to hand over their money. Laffer asked audiences, “Do you think that travelers continued to go through Sherwood Forest?”“Do you think that travelers continued to go through Sherwood Forest?”

His answer was, “No.”“No.” Taxpayers will avoid Sherwood ForestTaxpayers will avoid Sherwood Forest

to the greatest extent possible. They will lower their taxable incomelower their taxable income by reducingwork hours, retiring earlier, saving less, and engaging in tax avoidance and tax

evasion activities. Robin Hood and his men may end up with lessRobin Hood and his men may end up with lessrevenue than if they collected a relatively small “tax” fromrevenue than if they collected a relatively small “tax” fromeach traveler for passage through the forest.each traveler for passage through the forest.

The The “rich”“rich” Sherwood ForestSherwood ForestRobin HoodRobin Hood