The Great Depression of 1963-73

Those of us born in the mid-50s still can recall the Great Depression of 1963-73.  The trigger was obviously the Kennedy assassination.  A wave of sympathy led the federal government to go on an orgy of spending, taxes, regulation, inflation, and price controls.  Medicare and Medicaid was passed in 1965.  The War on Poverty was launched.  Affirmative action was imposed on business.  Inflation soared, pushing people into higher tax brackets.  Then LBJ raised income tax rates in 1968.  OSHA began imposing burdensome regulations on business.  Ditto for the EPA.  The US left Bretton Woods, causing enormous uncertainty over monetary policy.  By 1971 there were wage and price controls on the entire economy.  What a god-awful mess!

Of course the period from 1963-73 was actually one of the greatest boom periods in all of human history.  The question is why?

One answer is Adam Smith’s famous maxim: “There is a great deal of ruin in a nation.”

Or perhaps monetary policy drove NGDP up at a fast and accelerating rate.  And it is monetary policy, not structural factors, that explains the business cycle.

Karl Smith recently expressed similar sentiments:

I don’t think Krugman is doing this, but it is easy to get too caught up in thinking the macroeconomy is an extension personal finance. Having bought a house you couldn’t afford seems like a really bad situation to be in, and if everyone is in that situation then it seems like that ought to be really bad for the economy.

However, keep always in the front of your mind that a recession is not simply a series of unfortunate events.  A recession is when the economy produces less. For example,  the AIDS epidemic in Botswana is a horrible event for millions of people that uprooted lives and destroyed families and promises to leave a generation of orphans.

However, Botswana’s GDP growth didn’t turn negative until Lehman Brothers went under.

That a Global Financial Crisis could do what rampant death and disease could not, is an important indicator of the nature of recession.

A recession isn’t when bad things happen, whether that’s loosing your house to foreclosure or your parents to AIDS. A recession is when the economy produces less.

Somehow you have to make a link between the bad thing happening and the economy producing less. I maintain that, that link almost always runs through the supply of money and credit.

Still think “the problem” is the cost imposed on business by Obamacare?  Obamacare is “a problem,” as are many of the policies from 1963-73.  In the long run they may be more important than the business cycle.  But let’s not confuse policies that reduce the efficiency of the economy, with those that create business cycles.



45 Responses to “The Great Depression of 1963-73”

  1. Gravatar of Full Employment Hawk Full Employment Hawk
    17. March 2011 at 06:16

    Also, don’t forget that the economy worked much better for median income earners under the Clinton administration in which Clinton raised taxes on the upper income groups than it did under Bush Jr., who cut taxes, especially on the upper income groups.

  2. Gravatar of Jon Jon
    17. March 2011 at 07:01

    Surely it matters how those policies are perceived when enacted.

    For instance, if a certain set of policies is perceived as effective and growth inducing, there will be a temporary boom. Once public information emerges contradicting this, the boom will collapse.

    FEH: The boom and bust of the 90s has a lot to do with the ’95 telecom act. The connections are shockingly strong–not only the timing but the industries involved most in the boom; however, by the end of the decade, it was clear that the regulatory regime created by the act was unworkable. Once that became public knowledge, the boom collapsed. Hundreds of billions of dollars in network infrastructure suddenly when from being investment to being wasted consumption ‘rotting’ in the ground.

  3. Gravatar of Greg Ransom Greg Ransom
    17. March 2011 at 07:01

    “hardly any bubble in history which was not accompanied if not proceeded by strong growth in money and/or credit” — Otmar Issing at the IMF conference on modern macro.

    Here’s a longer version of the quote:

    “Quite a number of studies, now libraries almost, from the BIS and also from the European Central Bank have clearly shown that there is hardly any bubble in history which was not accompanied if not proceeded by strong growth in money and/or credit. So looking into money and credit will help you to identify a risky situation.”

    Scott, the empirical facts are in. Bubble exist — and money and credit produce them.

    As a Chicago economist, which rules, empirical evidence or apriori / scholastic RE theory?

  4. Gravatar of Charles R. Williams Charles R. Williams
    17. March 2011 at 08:39

    You have to be kidding. Your decade starts out with massive cuts in marginal tax rates at the highest brackets. From 90% to 70%. Now throw in a war paid for with deficits, the exception being the year of the LBJ 10% temporary tax surcharge. By August of 1971 the economy is in recession and inflation becomes a serious problem. Nixon institutes price controls, suspends convertibility of the dollar and guns the money supply to get reelected. The economy booms temporarily. Some of this is illusory because of price controls. Nixon is reelected, inflation soars and the economy heads into a severe recession followed by stagflation and a second severe recession. The period immediately following the golden decade 1963-1973 is a catastrophe as the structural imbalances of the previous boom drive the economy down.

    Some of this growth is the result of the Kennedy tax cut and some is the result of the catastrophic Nixon boom.

    The lessons of this period are 1) there really is a Laffer curve, 2) fiscal policy cannot be used to fine tune the economy, 3) some kind of rule-based monetary policy beats discretionary policy and 4) big increases in government spending are inflationary.

    Forty years have passed. There has been more innovation in finance in the last 40 years than the previous millennium. The fed is a big player in the business of financial intermediation. They are big enough to cause problems but the notion that the fed can manage the economy to full employment is really obsolete.

  5. Gravatar of Benjamin Cole Benjamin Cole
    17. March 2011 at 09:15

    More superb insights from Scott Sumner. I was worried when I started reading this post–what is Sumner driving at? But all is well–Sumner has a very good point to make.

    Monetary policy is very important.

  6. Gravatar of Scott Sumner Scott Sumner
    17. March 2011 at 09:38

    Full Employment Hawk, I won’t forget, as long as you don’t forget the the best years were 1995-2000, after the GOP took Congress, sharply cut cap gains taxes, did welfare reform, etc.

    Also don’t forget that whereas Clinton reduced the size of the federal government, Bush increased it. Those are lessons from which we could learn a lot.

    Jon, I doubt those differences would explain much.

    Greg, This isn’t a post about bubbles, it’s a post about regulation theories of recession.

    But as we learned in 1987 (identical to 1929), collapsing bubbles DO NOT CAUSE RECESSIONS.

    Charles, The Vietnam War certainly doesn’t explain the boom, as war spending declined significantly in the 5 years after 1968, but the economy remained very strong, with rapid GDP growth between 1968-73, even though 1968 was already a boom year. If you were right, real GDP would have fallen in 1968-73. (Yes, 1970 was a recession year, but an extremely mild recession.)

    I agree that some of these policies caused trouble later on–indeed that’s exactly my point. These sorts of policies have very long term effects, and don’t explain the business cycle.

    I agree that the Kennedy tax cuts helped the economy–but consider all the negatives I cited. Bush cut taxes in 2001, so one certainly cannot argue that tax cuts have a big impact on the business cycle. Monetary policy drives the business cycle.

    Thanks Benjamin.

  7. Gravatar of Bill Gee Bill Gee
    17. March 2011 at 10:12


    I have to take issue with your comment on “burdensome” OSHA regulations. Insurance Institute studies have shown that when companies comply with OSHA rules, they actually are able to improve productivity and reduce costs due to fewer workers compensation claims. Premium rates are also reduced when companies with high risk exposures can demonstrate safe workplace practices, which were developed by OSHA.

  8. Gravatar of Scott Sumner Scott Sumner
    17. March 2011 at 10:32

    Bill, I don’t agree with the claim that OSHA has improved workplace safety. I’ll so a post on that soon. In the meantime, you might look at research by Kniesner and Leeth.

    I do agree that safer firms have lower insurance costs.

  9. Gravatar of Nic Johnson Nic Johnson
    17. March 2011 at 11:44

    You should do some posts about advice for students, like Mankiw does.

  10. Gravatar of StatsGuy StatsGuy
    17. March 2011 at 12:42


    “In the meantime, you might look at research by Kniesner and Leeth.”

    OK, if you are going to use that paper, then you should pre-emptively think through its severe weaknesses.

    1, they write)

    “Our research is distinctive not only because we allow for a
    general background trend in mine injuries but also because do not simply attribute unexplained changes in injuries to mine safety regulation as we have direct measures of
    safety regulation enforcement.”

    And indeed, that’s just what they do. In other words, they assume an exogenous trend. Against this trend, they look for first differenced period-on-period impacts, with mediating variables (and a ton of instruments). Hmm, exogenous trends, with the trend entirely uninfluenced by _expectations_ of future enforcement. Instead, they are influenced by 15 lagged prior levels. Bloody brilliant. If I wanted to wipe out variation, that’s exactly what I’d do.

    For instance, imagine that a new president took office, and simultaneously increased penalties and enforcement. Let’s say there was an effect on reducing accidents. Since this effect occurs simultaneously across all areas, it gets absorbed into the time dummy.

    2, not only do they assume exogenous time trends, but exogenous location covariates (aka, dummies):

    “Exogenous variables include quarterly time dummies and mine district location dummies”

    OK, so each location has a “natural tendency” to have injuries, which is set exogenously to the impact of inspections (or the THREAT of inspections which was present at the point the mine was designed/built/commissioned). AKA, long term investment decisions are uninfluenced by long term expectations of policy enforcement.

    Seriously. Wrong.

    3, they only focus on IMMEDIATE THREATS)

    Of ALL possible workplace hazards, the ones that are MOST easily enforced by individuals through legal mechanisms are workplace accidents, because it’s easy to establish causality. Thus, this is precisely where would expect public enforcement (aka, police patrols) to be less effective than decentralized enforcement (fire alarms).

    They write:

    “Mine-related diseases develop gradually so that it is unlikely we can adequately determine the effect of MSHA
    enforcement efforts on miner health using information spanning the 15 years available. Accordingly, we exclude from the original data set all inspections focusing on health
    (such as inspections of a mine’s ventilation system or monitoring for dust, noise or silica).”

    Let me ask you, how many firms insure their workers for black lung? For cancer? Few. The harder causality is to link to a single cause (as is true in cancers or other probabilistic diseases), the longer the duration, the less well the justice system is at enforcing liability. Among other things, mines can go bankrupt (and are often designed to, via limited liability structures). This simply means that whatever result one gets for accidents cannot be simply extrapolated to long term health impact.

    At least they admit this is a weakness, but then they dismiss it as probably unimportant.

    4) They use an innappropriate model. That is, they use a continuous model when they should be using a count model (poisson or negative binomial). Because events are unlikely in general and correllated when they occur, it’s utterly absurd that their dependent variable follows a normal distribution (where spikes are massively improper). This leads to biased and exceptionally improper estimates. Moreover, even if they DID use the proper model, they would need to drop many variables from the model, because non-linear models generate lower accuracy in latent parameter estimates. Adding more “controls” often does not improve the model. It simply absorbs variance.

    5) Please don’t feed me their bull about “running 200 models and cherry picking the best”. If you run 200 models, all of which share the same structural flaws, they’re not independent models. Go review the literature on model selection and dealing with model correlation in construction of ensemble models.

    Averaging 200 wrong models does not yield a right model.

    Indeed, I would be interested in the distribution of parameters – I expect there’s a lot of positive effects (MSHA _increased_ injuries) in their models. Really? I could imagine no effect, but an increase? In fact, I would expect their average model to show a positive influence of MSHA, since their most negative model didn’t even yield a significant effect, even though they ran 200 models and we’d expect a 95% significant effect on average 1/20th of the time. That suggests a positive skew to their average (which, of course, they don’t share…. hmm).

    Then they go and make silly statements like spending 27.5mil on heart defibrillators saving 16,000 miner lives. Um, yah.

    What a total hack job.

    Having said all of that, I don’t disagree with certain conclusions. Sure, decrease the # of mine inspections. Do them randomly, at half the average frequency, and increase penalties by a factor of 20. Then force MSHA to become self-funding to avoid capture.

  11. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. March 2011 at 12:52

    I’ll not argue against your points concerning negative supply side policies in the 1960s. But I will argue that they were minor in comparison to some very lucky positive supply side policies that bore fruit in the 1960s. (Mostly, I’m trying to add some nuance to your larger point.)

    First, total facto productivity growth was especially strong in the late 1950s through the mid 1960s (3.0% on average from 1958 through 1966), probably because of investment in the Interstate Highway System (according to Alexander Field’s research). (By comparison TFP growth only averaged 0.5% from 1973-95.) Secondly, as Charles points out, there was an important reduction in marginal personal income tax rates during this period, probably far more important than anything that came later. This is true even when one takes into account the effective tax burden due to credits, deductions, exemptions etc.

    Thus, the 1960s were a lucky coincidece of a couple of very effective supply side policies, in a sea of very minor bad ones, along with a highly stimulative monetary policy. That’s what put the soaring into the “soaring sixties”.

  12. Gravatar of Greg Marquez Greg Marquez
    17. March 2011 at 14:08

    Maybe it makes more sense to think about it this way: Absent the growth in the money supply would the economy have still grown at such a high rate?

    Here’s another question: Imagine we wanted to turn this recession into a depression; what, if anything, could we do to the money supply to achieve that result?

    I seem to recall from my Econ 102 class that during the great depression the argument that money was too tight was rejected because interests rates were almost zero, our professor argued that real interest rates were actually less than zero, i.e. money was becoming more valuable, and so even close to zero nominal interest rates were way too high. Was he wrong? Was this later proven to not be the case? Or is everybody just ignoring monetary theory?

  13. Gravatar of Full Employment Hawk Full Employment Hawk
    17. March 2011 at 14:28

    “Also don’t forget that whereas Clinton reduced the size of the federal government, Bush increased it.”

    Once the economy reaches potential output, the federal government should be running surpluses and reducing the federal debt, except that this should not be done by underfunding investment in infrastructure and human capital.

    Unfortunately Bush misused the surpluses to cut taxes instead of paying down the federal debt.

  14. Gravatar of Bababooey Bababooey
    17. March 2011 at 14:56

    But if policies cause people to hoard money, doesn’t that first make money & credit tight and then reduce the efficacy of increasing monetary supply? People don’t hoard in their mattress, but buying treasuries and gold at higher prices is less good than making investments that create jobs and increase productivity.

    I think that’s why you dislike the Fed policy of paying interest on reserves, because it keeps money in reserve instead of on its way to find a higher return.

    As always, I don’t actually know enough to disagree with your point, but I am wondering….

  15. Gravatar of W. Peden W. Peden
    17. March 2011 at 15:55

    Full Employment Hawk,

    “Once the economy reaches potential output, the federal government should be running surpluses and reducing the federal debt, except that this should not be done by underfunding investment in infrastructure and human capital.

    Unfortunately Bush misused the surpluses to cut taxes instead of paying down the federal debt.”

    Agreed. Clinton had the US on the right path. Government restraint frees up the money stock for use in industry, providing jobs, output and revenues. Supply side economics and Keynesianism combined have done horrific things to the US public finances over the decades.

    Fiscal restraint may not equal monetary stability, but it does prevent “crowding out” under a monetary regime like inflation targeting (or NGDP targeting, for that matter).

    I also think that qualities of fiscal policy are just as important as the quantity in the direction of fiscal policy, e.g. a tax system that doesn’t discourage investment and enterprise through capital gains taxes and corporation taxes is desirable. I would tolerate much higher progressive income taxes with less deductions etc. if it was coupled with the abolition of capital gains tax and corporation tax.

  16. Gravatar of JimP JimP
    17. March 2011 at 16:00

    Japan starts to print. At last.

  17. Gravatar of Lorenzo from Oz Lorenzo from Oz
    17. March 2011 at 21:14

    Since this is a “monetary policy matters” post, I have a question: how much does use of representative agent models in macroeconomics impede considering the effect of monetary policy? When you see comments/arguments that it is “real” effects and the “real” economy that matters, the implicit notion is that money is neutral, because it is transparent. We can “see through” to its real price. That makes a sort of sense if you are using a representative agent model, because the representative agent is in the middle of all information flows.

    But that is, of course, not how things work. There is a lag in how quickly people can perceive what is happening to the real price of money (which is a shifting aggregation anyway). People do their actual economic signaling with money whose nominal value is clear, but whose real value is less so. And less so to varying degrees. (A sudden shift in its real price is likely to take time to register, certainly time to work its way through contracts.) But it is hard to see how you can register that with a representative agent model of macroeconomics.

    (These ruminations were prompted by reading this post by Arnold Kling.)

  18. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. March 2011 at 21:21

    Lorenzo of Oz wrote:
    “These ruminations were prompted by reading this post by Arnold Kling.”

    Bleech! Who bothers to get their opinions from Kling?

  19. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. March 2011 at 21:41

    What would you like to be most in the whole world:

  20. Gravatar of Pacemaker Pacemaker
    18. March 2011 at 04:51

    Lurker here but I’ve been reading your blog since Tyler Cowen first linked here. Anyway, Mankiw just linked to a recent paper of his that implicitly endorses NGDP targeting when short-term interest rate cutting fails:

    “The second level of the hierarchy applies when the short-term interest rate hits against the zero lower
    bound. In this case, unconventional monetary policy becomes the next policy instrument to be used to
    restore full employment. A reduction in long-term interest rates may be sufficient when a cut in the short-term interest rate is not. And an increase the long-term nominal anchor is, in this model, always sufficient to
    put the economy back on track. This policy might be interpreted, for example, as the central bank targeting
    a higher level of nominal GDP growth.”

  21. Gravatar of marcus nunes marcus nunes
    18. March 2011 at 05:47

    Krugman provides an openning for the adoption of NGDP level targeting. It fits well with the “stop talking about inflation” view of NGDP targeting.

  22. Gravatar of Cameron Cameron
    18. March 2011 at 05:53

    Did Krugman just argue that monetary policy will be ineffective for political reasons…?

    But… isn’t additional fiscal stimulus much much much less likely than monetary stimulus at this point?

    This strikes me as amazingly inconsistent. If you are going to disregard monetary stimulus because you don’t think it’s likely you should disregard fiscal stimulus too… Or you should at least support both ecstatically, rather than like this:

    Also :

    “I supported fiscal expansion in 2008-2009 precisely because I didn’t believe that the kind of commitment-based unorthodox monetary policy that works in the models could, in fact, be implemented in practice. Nothing I’ve seen since has changed my views on that subject.”

    It’s pretty upsetting to see that QE2 didn’t convince him monetary policy can be effective. I remember him belittling ignorant wall street traders when about the increase in inflation expectations during the anticipation of QE2… There hasn’t been any subsequent move to show he was right. I wonder what he thinks has driven the recovery since September?

    I know you’re busy , but I hope you get a chance to do a post related to some of his recent blog posts sometime soon (i.e. he recently claimed we were in a liquidity trap because interest rates haven’t risen despite high budget deficits – huh?).

  23. Gravatar of marcus nunes marcus nunes
    18. March 2011 at 06:04

    Better: “stop obsessing about inflation”. And this is the “funny” conclusion of Mankiw´s paper linked to on the PK post:
    “A sufficiently flexible and credible monetary policy is always sufficient to stabilize output following an adverse demand shock, even if the zero lower bound on the short-term interest rate binds”.
    If it is “flexible and credible” it can surely avoid the adverse AD shock to begin with!

  24. Gravatar of Scott Sumner Scott Sumner
    18. March 2011 at 06:46

    Nic, Don’t have time.

    Statsguy, First of all, I’ve never read the mine safety paper, so I can’t comment. They have done a number of studies, using different techniques. Others have done studies as well. The weight of empirical evidence suggests that OSHA has not significantly improved safety.

    I would add that the theoretical presumption is that the free market should provide the optimal amount of safety, so any improvements that might have occurred as a result of OSHA are non-optimal.

    They found the biggest impact on worker safety is compensating wage differentials, as you would expect. The second biggest was worker compensation insurance. It’s not clear OSHA had any effect, and if it did it’s not clear why that would be a good thing.

    Mark, I’d have to look at the tax data. My understanding is that tax rates fell in 1964, but rose (in real and nominal terms) for the rest of the 1960s. So I’m not sure that explains the boom, although it certainly helps explain the early part of the boom.

    Also recall that the 2001 tax cuts didn’t seem to have a major impact.

    Greg, You said;

    “Maybe it makes more sense to think about it this way: Absent the growth in the money supply would the economy have still grown at such a high rate?”

    That’s right, and the answer is no.

    Real interest rates were initially high, but quickly declined. I don’t find them to be a reliable indicator of monetary policy.

    Full Employment Hawk, Bush also squandered the surpluses on homeland defense, Medicare drug benefits, education and wars.

    Bababooey, I don’t consider buying Treasuries or gold to be “hoarding.” Yes, it seems unproductive, but the person who sells the Treasuries or gold will then have more money. Unless they hoard money, net hoarding does not rise. When hoarding of money is a problem, any spending of money, on anything, is better than putting it under a mattress.

    JimP, Thanks, I mentioned that in my newest post.

    Lorenzo, I’m not sure it matters all that much, as long as you have sticky wages and prices. The problem is that economists have never agreed as to why wages and prices are sticky, so that behavior is difficult to model.

    Pacemaker, Thanks. I’ve already written a post on that, and will post it soon.

    Marcus, That Krugman reply is pretty lame. Fiscal policy raised unemployment from 7.8% when Obama took office, to 9.8% in November 2010. In November 2010 the Fed adopted QE2, and unemployment has fallen to 8.9%. And he considers that an argument that fiscal policy works better than monetary policy?!?!

  25. Gravatar of Morgan Warstler Morgan Warstler
    18. March 2011 at 07:56

    It has to go somewhere:

  26. Gravatar of Morgan Warstler Morgan Warstler
    18. March 2011 at 08:24

    I’d like to imagine a scenario and get your feedback…

    What would happen if Greenspan, Clinton, and Bush stepped forward and said:

    Clinton: I was going to do a bunch of new spending “investing” but Alan told me not to and he’d keep the rates lower, so I gave up on investing, but I did raise taxes since I didn’t want to have to cut as much as he wanted.

    Alan: That damn Clinton went and raised taxes, and didn’t make cuts as big as I wanted, and brought the budget into balance, which allows a possibility of more government programs that help the Dem voters – so when Bush won, I went out and said PLEASE deficit spend.

    Bush: I was more than willing to cut taxes the way Alan originally wanted, the mistake I made was not making the government be more productive – cutting public employee pensions and the like.

    Alan: My real mistake was not tightening money up in 2004, right after George got re-elected, we had a war going, the deficit was getting bigger – we could have comfortably left whichever President won with a big enough deficit, they wouldn’t be able to do any real new programs for Dem voters.


    I’ll contend this is very close to reality – and if it were not for the public employees having gained as much $$$ to influence elections under Bush, we’d be further into the future (which is progress) then we are now.

    I’m just interested what you think would happen if this stuff got said out loud – it became “known” knowledge.

  27. Gravatar of StatsGuy StatsGuy
    18. March 2011 at 08:57


    “The weight of empirical evidence suggests that OSHA has not significantly improved safety.”

    I would love a summary of this evidence, since you are confident in it. I have no opinion either way, other than it would probably be better to do many fewer inspections and charge much higher penalties.

    If this is the “best” of the available evidence, however, I’m not impressed.

  28. Gravatar of marcus nunes marcus nunes
    18. March 2011 at 09:53

    A “war” is being played out: The ZLB guys led by PK and the OB (“obsession bound”) guys led by the likes of Plosser and Fisher. Mankiw steps in but doesn´t help resolve the issue. It seems the perfect time to advocate NGDP level targeting:

  29. Gravatar of Bababooey Bababooey
    18. March 2011 at 11:45

    “My understanding is that tax rates fell in 1964, but rose (in real and nominal terms) for the rest of the 1960s.”

    The highest income tax rate dropped from 91% to 70% during the 1960s.

    But don’t make that argument. Like FOMC interest rates, tax rates are often cited, but poor evidence for the thing being discussed. Comparing tax rates across geography or time is pointless.

    If you’re curious why, flip through the tax code, read about collapsible corporations, General Utility, passive activity, CFCs, assignment of income, etc. (Even so called “effective rates” are difficult to compare.) Internal Revenue Code provisions mostly react to successful strategies, but set the maze for the next generation of our brightest minds to waste their gifts on playing Theseus to the IRS Minotaur.

    The AMT was enacted because a 1967 Congressional hearing revealed that, notwithstanding a 70% income tax rate, 155 of the wealthiest Americans paid no income tax at all. People with money find a way.

  30. Gravatar of flow5 flow5
    18. March 2011 at 13:28

    In the late 50’s & early 60’s, bankers seeking to get a bigger share of the loan-pie, began buying their legislators and their liquidity.

    The prevailing hubris on the FED’s technical staff, stemming from their Keynesian training, advised them: that interest was the price of money, not the price of loan-funds. They therefore decided that the money supply could be controlled through the manipulation of the federal funds rate (the rate paid by banks to banks holding excess legal reserves in the Reserve Banks,).

    The operations at the “trading desk” began to be dictated by the Fed Funds “bracket racket” in 1965. Inflation was the inevitable consequence.

  31. Gravatar of Old Whig Old Whig
    18. March 2011 at 15:19

    It’s seems to me that macro economic theories contra micro economics, individual behavior, bears a strong resemblance between the inherent problems in physics.

    It’s so far been impossible to get a comprehensive theory to combine quantum physics, Einstein et al, with Newtonian physics. It’s not been possible to bridge the two.

    I think that macro economics suffer from the same problem. It holds explanations for macro problems but are unable to get it down into micro, to get individual actors to act as the theory proscribes.

    Until macro and micro economics converge, we should be very sceptic about grand theories trying to explain how we can by grand policy change individual behavior.

  32. Gravatar of Mark A. Sadowski Mark A. Sadowski
    18. March 2011 at 17:13

    You wrote:
    “Mark, I’d have to look at the tax data. My understanding is that tax rates fell in 1964, but rose (in real and nominal terms) for the rest of the 1960s. So I’m not sure that explains the boom, although it certainly helps explain the early part of the boom.

    Also recall that the 2001 tax cuts didn’t seem to have a major impact.”

    I double checked the data (Piketty and Saez have a number of good papers on the subject) and I need to correct what I said. Effective personal income tax rates at the top end of the income distribution didn’t really start to fall until the 1980s. Nevertheless I would argue that marginal tax rates often matter since decisions are made at the margin.

    The decline in marginal rates didn’t matter in 2001-2003 because the decrease was from 39.6% to 35%. This boosted after tax income at the margin by only 7.6%. In contrast the decrease from 90% to 70% in 1964-1965 increased after tax income at the margin by a whopping 200%.

    This is a point that Bruce Bartlett has made many times. There’s a decreasing marginal benefit to reducing top marginal rates (as there is with almost everything). When they were 90% it made a heck of a lot of sense. Now that they’re only 35%, not so much.

  33. Gravatar of Lorenzo from Oz Lorenzo from Oz
    18. March 2011 at 17:22

    The problem is that economists have never agreed as to why wages and prices are sticky, so that behavior is difficult to model. Some enterprising economist could do a Ronald Coase and ask folk. (That’s how he came up with the notion, if not the label, of transaction costs: to my mind, the biggest single intellectual breakthrough of C20th economics–just start counting how many Nobel prize worthy-work has incorporated transaction cost thinking.)

    Thinking out aloud here, stickiness likely comes from managing (inter)action across time and the role of money as “markers/offers/signals”, the language of transactions. The nominal price of money has a stability and immediate knowability that real price does not. (Consider speaking in a language, or doing mathematics, where the value of a key component is uncontrollably variable and then using it for some agreement: even indexed agreements are after-the-fact–there is also the striking fact that such agreements are not more used.) So, the “language of transactions” has a significant “noise” factor (which people are clearly prepared to tolerate up to a point before various forms of indexing start kicking in: probably connected with the expected rate of change within the contractual time period/price decision-loop). So, maybe the problem is that using too few representative agents make stickiness more of a mystery than it should be.

    For example, a corporation takes time to process information and makes decisions. Though even a small business agonises over the effect on sales of price changes: the more differentiated your product, the more that is so (since the less information you have to work from: says the part-owner of a business that puts on historical incursions for schools–we have bookings up to a year ahead, which adds to the fun and helps make our prices “sticky”).

  34. Gravatar of Lorenzo from Oz Lorenzo from Oz
    18. March 2011 at 19:42

    BTW More and more of the US economy is moving into the realm of sticky wages and prices.

  35. Gravatar of mbk mbk
    18. March 2011 at 22:38


    I thought stickiness in all its forms came mainly through medium and long term maturities of contracts? Until a contract is renewed, its conditions stand. Hence, stickiness and stepwise adjustment in all economic transactions that use contracts (real or implied). Yes there may be a psychological stickiness too – a form of money illusion – but I’d venture the contract mechanism is a real and proximate cause.

  36. Gravatar of Lorenzo from Oz Lorenzo from Oz
    19. March 2011 at 02:27


    Yes, but
    (1) why do people have contracts?
    (2) why are contracts not automatically indexed to real prices?

    The notion that you do not have sticky prices is a notion that all transactions are what I call “bazaar swaps”. One-off swaps on the spot, so prices can shift from one transaction to the next. Clearly, not all transactions are like that, even for non-capital goods.

    So, why do people have on-going contracts that bind their transactions across time periods? And why are those contracts nominal and not indexed?

    It is like the Coasian question: why are there firms? Why are not all transactions one-off interactions in the market place?

    The Coasian answer is: transaction costs. Though I also like the Barzellian answer: the boundary of a firm is the boundary of the guarantee of its equity capital. So, combining the two, it is the intersection of comparative transactions costs and risk coverage that sets the boundary of the firm.

    It is likely that one gets the same answer for contracts. A contract is a way of reducing transaction costs and managing risks. Contracts reduce transaction costs (you do not have to keep finding folk, you build up information and trust) and manage risk (you can plan ahead) while nominal prices minimise information and enforcement costs within the contract.

    Hence sticky prices from contracts with nominal prices.

    (And I completely made that up as I went along: thanks for asking the question.)

  37. Gravatar of Lorenzo from Oz Lorenzo from Oz
    19. March 2011 at 02:29

    I was going to suggest that perhaps macroeconomics could do with some game theory. I guess not.

  38. Gravatar of The Numeraire The Numeraire
    19. March 2011 at 03:03

    “Mark, I’d have to look at the tax data. My understanding is that tax rates fell in 1964, but rose (in real and nominal terms) for the rest of the 1960s. So I’m not sure that explains the boom, although it certainly helps explain the early part of the boom.”

    There were other important tax changes from 1963-1973 which you didn’t discuss. The period of 1963-73 was not a continuous boom; after the growth surge there was a lull from mid-1968 through 1970 followed by a modest boom from 1971-1973 amidst the backdrop of heavy inflation and Nixonian price controls. Tax policy during this period coincides fairly well with the timing of the booms and lulls.

    The Kennedy tax cuts were put in place in two steps in 1964-65 and involved a 30 percent decrease in marginal tax rates, across-the-board. The large tax cuts plus the coinciding growth creating a very large surge in personal disposable income over those two years.

    Growth was robust until mid-1968 when LBJ signed into law his wartime surtax, which applied retroactively to the quarter in which it was signed into law (a 10 percent surtax applied to three-fourths of calenday year 1968 equalling a 7.5 percent surtax). Quarterly RGDP growth in 1968 slows from 8.5 percent Q1 and 7.0 percent Q2 to 2.8 and 1.7 percent in the second half. During the period of the imposition of the surtax, the economy enjoys only one quarter of growth in excess of 3 percent — from 1964-1968 annual growth was in excess of 5 percent.

    The surtax was dropped in 1970 (offset by a foolish hike in the capital gains tax) but a more important change was made during 1971 and 1972 when Nixon lowered the top marginal rate on “earned” income (wages, salaries etc.) to 50 percent but kept the more familiar 70 percent rate in place to apply to unearned income (interest, dividends, royalties etc). This seldom-discussed tax cut appears to have had a positive effect and was also accompanied by large investment tax credits and some adjustment to the basic personal exemption. As such and contrary to your assertion, bracket creep was not a meaningful problem until later on in the 1970’s (in 1979-1980 there is a large surge in federal tax receipts/GDP despite no legislated tax changes).

    “Also recall that the 2001 tax cuts didn’t seem to have a major impact”

    The 2001 were not anywhere near being a 30 percent across-the-board tax cut. Also, recall that JGTRRA 2001 bill initially called for slow phase-ins of the proposed tax cuts. The top rate for instance had only declined half a percentage point per year from 2000-2002. It was JGTRRA 2003 that accelerated the phase-in to the full 35 percent tax rate immediately and also added reductions in capital gains rates and dividend taxation. The turn in the economy and stock markets coincides fairly nicely with the passage of that tax bill.

  39. Gravatar of The Numeraire The Numeraire
    19. March 2011 at 03:20

    “Still think “the problem” is the cost imposed on business by Obamacare?”

    I’d agree that it is not THE major underlying problem (most folks would), but Obamacare is a problem specifically because the employer mandate discourages firms that are larger than the employee threshold from taking on new hires. Obamacare discourages growth of the firm and also encourages a firm to outsource some of its activities to smaller (or foreign) firms that are not subject to the mandate. I find it hard to believe that the initial OSHA regulations and the then-modest Medicare payroll tax established in the mid to late 1960’s are explicity anti-growth in that they would act as a wedge regulating the employee headcount of an enterprise the way the employer mandate almost certainly does.

    For a small enterprise aiming to grow large, the threshold at which the employer mandate sets in is the equivalent of a large marginal tax hike.

  40. Gravatar of Scott Sumner Scott Sumner
    19. March 2011 at 10:26

    Morgan, Looks like you are right. From The Economist, an article called Betting on Green:

    “Ten years ago, no analyst in the world would have predicted 650m cellphone subscribers in India but only 300m people with access to latrines and toilets.”

    Don’t you think that’s a pretty conspiratorial view of monetary policy? I assume these guys are just doing the best they can.

    Statsguy, Theory predicts it shouldn’t work, where is the evidence that it does? The burden of proof is on those who do want regulation, when theory suggests it is unwise. I have a new post, but I plan to add another update when my computer starts working. I can’t access my blog right now.

    Marcus, Thanks, I responded in a recent post.

    Bababooey, That’s right, my only point was that those who cite lower MTRs, must also account for the rise in MTRs after 1965.

    flow5, That was one mistake, there were many others as well.

    Old Whig, That’s a very good analogy.

    Mark, That’s a good point, but again, rates did start rising again after 1965. In any case, none of this changes my real point, that things like Obamacare couldn’t have been that important.

    Lorenzo, I think Alan Blinder tried that. One problem is that people might not know why they behave in certain ways. Another is that there may be many different types of stickiness. Some changes occur at specified times, others occur when actual prices have deviated from equilibrium prices by a specified percentage.

    mbk. No, contracts are not the main reason for sticky prices, it is simply company practices.

    Numeraire, I agree with much of what you have to say, but the bottom line is that government got dramatically more intrusive under Johnson and Nixon, far more so than under Obama, so government intrusion doesn’t explain business cycles. If someone wants to single out taxes and build a theory, then I agree it has some explanatory power, but not all that much. If Clinton had cut taxes, instead of raising them, then supply-siders would have attributed the 1990s boom to the Clinton tax cuts.

    Here’s where I do agree. Some part of the 1920s, 1960s, and 1980s booms were due to the supply-side effects of tax cuts. I don’t know how much, I suspect the role was modest but non-trivial. Perhaps one could also make a claim for the cap gains cut of 1996, and the 2003 tax cuts. In the very long run I think tax rates are extremely important, and help explain differences in hours worked between countries. But that’s not business cycles.

  41. Gravatar of Scott Sumner Scott Sumner
    19. March 2011 at 10:30

    Cameron, Yes, he has been very disappointing recently. The evidence massively contradicts his arguments. Karl Smith did a good post criticizing his liquidity trap argument.

  42. Gravatar of TheMoneyIllusion » The Wizard of the Fed TheMoneyIllusion » The Wizard of the Fed
    20. March 2011 at 17:51

    […] recent changes can explain the slow NGDP growth, and if that’s not persuasive enough then consider that the economy boomed in 1963-73, when government activism was far more aggressive than today.  Furthermore, a large share […]

  43. Gravatar of The Numeraire The Numeraire
    21. March 2011 at 03:37

    “government got dramatically more intrusive under Johnson and Nixon, far more so than under Obama, so government intrusion doesn’t explain business cycles.”

    The markets have all along been discounting the degree to which Obama and Congress would implement government intrusion. In the past two years, we’ve went from an environment of heavily planned intrusion (carbon tax, health care mandate, tax hikes) to an almost complete reversal (extension of supply-side tax cuts, widespread talk of tax reform, a dramatic change in the composition of Congress, no momentum for card check or carbon taxes). The end result: steady improvement in the financial markets and the economy — what the market was likely discounting 18-24 months is a far cry from what has been put in place and what currently remains on the table.

    Without some of this reversal in policy direction, any attempts to QE ourselves to prosperity would probably do more to raise the price component of NGDP than the real component.

    “If Clinton had cut taxes, instead of raising them, then supply-siders would have attributed the 1990s boom to the Clinton tax cuts.”

    This already is the supply-side narrative because it is largely true. Clinton raised tax rates early in his first term, which did nothing to aid growth in the immediate period following the tax hike and probably handed Congress to the other side. The remainder of Clinton’s term was spent largely building bridges with supply-side Republicans allowing for the capital gains tax cut, Roth and 529 savings accounts, telecom deregulation etc. On balance, economic policy was more market-oriented and less intrusive, and it’s easy to find people who fashion themselves as supply-siders who will tell you such.

    “Some part of the 1920s, 1960s, and 1980s booms were due to the supply-side effects of tax cuts”

    All three tax cuts cited are relevant not just for their size but for their timing. In each period prior there had been considerable bracket creep — from either inflation or from having tax brackets that had remained static during a period of growth. The 1950’s are one such example – a stop-and-go economy which produced modest per capita growth was slowly pushing households into higher tax brackets. The Kennedy tax cuts were the perfect remedy for the creeping stagnation in real disposable income that was taking place.

    “I don’t know how much, I suspect the role was modest but non-trivial.”

    If tax policy was modest at best, then how does monetary policy explain the booms of the 1920’s or 1960’s. Monetary policy certainly did not produce stable NGDP in either period, something which you appear to regard as crucial. In fact, in the immediate boom years following the Kennedy tax cuts, trying to stabilize NGDP would have needed to involve shrinking the high levels of RGDP growth.

    In the 1920’s, the economy appeared to be swimming against an improper monetary policy — a gold parity that did not reflect the postwar price level, popularity amongst central bankers with respect to the Real Bills doctrine, conducting U.S. policy to accomodate and comfort the harshness of policy in Britain and Europe etc. Yet, despite said monetary policy, the economy and financial markets in the U.S. did fairly well after the supply-side tax cuts (France also boomed after supply-side tax cuts in 1926; the Brits had no boom due in large part to the deflation brought upon by attempting to restore the pound fully to its pre-war gold parity, but also because they did little to bring down the wartime tax rates).

  44. Gravatar of ssumner ssumner
    21. March 2011 at 08:08

    Numeraire, Those are good points, and I have made many myself when arguing against anti-supply-siders. I consider myself a moderate supply-sider. In the long run taxes are more important than monetary policy. But I don’t accept your view of money. NGDP grew relatively fast during 1963-73, and at an accelerating pace. That’s not ideal and is one reason we had problems after 1973. But it will tend to produce solid growth for a while.

    I believe that after the 1921 depression (caused by tight money) the rate of NGDP growth was about 3% to 4%, which was reasonable. As soon as NGDP started plunging after September 1929 (due to tight money) RGDP also plunged, even though tax rates were quite low until later in the Depression.

    In another thread I meantioned Argentina before and after 2002, which is a textbook example of how in the short run good monetary policy is much more important than good policy in other areas. Argentina has boomed under a leftist policy regime since 2002, after being in depression under a more neoliberal regime in 1998-02. All because of monetary policy.

  45. Gravatar of The Numeraire The Numeraire
    22. March 2011 at 08:31

    Scott, Argentina did not have “good policy in other areas” from 1998-2002.

    Argentina had the same problem all the other dollar-linked countries (Asian Tigers, Russia, Ecuador etc.) had to deal with; the rapid rise in the real exchange rate of the dollar beginning in 1997. The strong dollar was especially hard on Argentina because the country is relatively dependent on commodity exports and because during the 1991-97 reform and growth period, all sectors of the economy took advantage of monetary stability to increase debt. Falling commodity prices in 1998-99 shrunk nominal incomes at a time when the real value of debt was rising.

    Argentina unwisely chose to maintain the dollar/peso fix AND accepted poisonous IMF advice to raise taxes to attempt to balance the budget (the rationale being that a balanced budget would restore investor confidence; despite the fact that there was no lack of confidence prior to 1997 when the gov’t ran deficits every single year).

    Argentina would have contracted far less if taxes were not raised (taxes were raised 3 times under IMF programs in an 18-month period beginning in Jan. 2000). Ecuador recovered faster after suffering a depression in 1999 by holding the line on taxes and dollarizing. Thailand and Malaysia recovered by abandoning the IMF doctrine to raise taxes and devalue further. Russia turned up immediately after ending IMF programs and implementing a flat tax regime. Taxation is not a long-run phenomenon – its effect can be every bit as immediate as a change in monetary policy and also widely discounted in market expectations.

    The boom in Argentina since 2002 is somewhat of an illusion. If Argentina had not contracted so much in the first place, there would be less potential for post-depression growth. GDP per capita and total factor productivity is only now approaching post-crisis levels. Some other factors to consider;
    – if global commodity prices and global growth had not risen as quickly post-2002, Argentine exports and real incomes would not have grown nearly as fast. Domestic policy did not create this fortunate outcome — in fact, the gov’t receives a great deal of tax revenue from export tariffs

    – prior to the peso devaluation and extinguishing of dollar-denominated contracts, Argentines were able to transfer a huge sum of dollars out of the country and into mattresses. Most estimates state that $100 billion of capital (1/3 of GDP) escaped the effects of devaluation. After the devaluation and economic contraction was finished, this capital was able to return and buy peso-denominated assets on the cheap

    – the central government repudiated its debt and defaulted on its debt service. This obviously gave the gov’t wider latitude for domestic expenditure, but arguably did far worse damage by crumpling the credit markets for all sectors of the economy and by diminishing FDI (despite the potential for greater FDI owing to the commodity boom)

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