Parents are now getting questions like this from their children. Dad, Do we believe in Supply-side , Voodoo , Doodoo , Trickle-down or Girlie Men economics? Supply-side Economics Voodoo Economics Doodoo Economics Balanced -Budget Economics Girlie Men Economics
THE INFLATION-UNEMPLOYMENT RELATIONSHIP <ul><li>Normally, there is a short-run trade-off between the rate of inflation and the the rate of unemployment. </li></ul><ul><li>Aggregate supply shocks can cause both higher rates of inflation and higher rates of unemployment. </li></ul><ul><li>There is no significant trade-off over long periods of time. </li></ul>
0 PL 1 Y 1 AD 1 SRAS Effect of Changes in AD on Real Output and Price Level Price Level Real domestic output
o PL 1 PL 2 Y 1 Y 2 AD 1 AD 2 SRAS E ffect of C hanges in AD on Real Output and P rice L evel Price Level Real domestic output
o PL 1 PL 2 PL 3 Y 1 Y 2 Y 3 AD 1 AD 2 AD 3 SRAS EFFECT OF CHANGES IN AD ON REAL OUTPUT & PRICE LEVEL Price Level Real domestic output
o PL 1 PL 2 PL 3 PL 4 Y 1 Y 2 Y 3 Y 4 AD 1 AD 2 AD 3 AD 4 SRAS Effect of Changes in AD on Real Output and Price Level [ Good News-Bad News ] Price Level Real domestic output
The Phillips Curve Trade-Off A Phillips Curve trade-off between unemployment and inflation . Increases in AD causes . . . B C AD 1 AD 2 A AD 3 Phillips curve C B A AS PC PL Y/Empl. UNEMPLOYMENT RATE INFLATION RATE REAL OUTPUT PRICE LEVEL
Shifting Phillips Curve Output & Employment Unemployment Stag flation Shifts in AS PL Cause shifts in the PC AD Inflation AS 1 AS 2 AS 3 AS 4 AS 5 PC 1 PC 2 PC 3 PC 4 PC 5 The unemployment-inflation experience of the 1970s & 1980s demolished the idea of an always-stable Phillips Curve .
The Phillips Curve Trade-Off A Phillips Curve trade-off between unemployment and inflation . Increases in AD causes . . . AD 1 AD 2 AD 3 Phillips curve C AS PC PL Y/Empl. B A D E C to B would be like AD1 to AD2 C to A like AD1 to AD3 C to D like AD3 to AD2 C to E like AD3 to AD1 PL3 PL2 PL1 UNEMPLOY. RATE INFLATION RATE REAL GDP PRICE LEVEL
Inverted Phillips Curve [“Swerve] ”[late 90s] The Crocodile Hunter the Fed Still Listens To Alban 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 advances and global competition. [the so-called “ new economy ” ] However, Alan Greenspan still believes in the SRPC trade-off. 97 98 The new economy was really just a favorable supply shock [oil dropping from $26 to $11] and a speedup in productivity.
Phillips “Curl” Unemployment got worse but so did inflation .
Incomes Policies – Wage and Price Controls Wage & 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. 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 classifications ) into legal promotions 4. Workers can’t freely bargain for wages 5. The public quickly tires of this . 6. The Market can’t equate QD and QS . 7. Economists reject this approach to reducing inflation. Kublai Khan
Inflation - Unemployment Relationship <ul><li>Normally, there is a short-run trade-off between the rate of inflation and the the rate of unemployment . </li></ul><ul><li>AS shocks can cause both higher rates of inflation & higher rates of unemployment . </li></ul><ul><li>There is no significant trade-off over long periods of time . </li></ul>
Wage-Price Controls To Control Inflation [1971 & 1973 – both failed] President Nixon came into office as a strong opponent of wage-price controls to control inflation . However as inflation edged over 5% in summer of 1971 , he did try it for 90 days . In August of 71, Nixon announced to the nation on a Sunday night (pre- empting “Bonanza”) , the 90 day freeze on wages. Nixon hoped he would not be perceived as a flip-flopper on this issue. The next day, 90% of the next day’s news were devoted to this issue. The DOW liked the news and shot up 33 points , as Nixon was perceived as “acting boldly” , and coming to the defense of the consumers against the “price gougers” . He also did it again in 73 but it didn’t work any better. His head of the OMB told him that they had convinced the public of their original position that, “wage & price controls don’t work to control inflation.” P rotesters against the N ixon Wage f reeze So-do wage & p rice c ontrols work to control inflation?
0 100 l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent)
0 100 m l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent)
0 100 m n l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent)
0 100 m m n l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent) Maximum Tax Revenue
Reaganomics The core of the supply-side theory was that lower marginal tax rates would cause people to “supply” more labor , working more and harder, which would increase growth – and the positive effect on growth would be so large that “G” tax revenue would actually increase rather than decrease in response to the tax cut. [Ave. 23% cut] “ I was on the Laffer curve.”
0 100 m m n l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent) Maximum Tax Revenue President Reagan said he was on the Laffer curve. He said that after WW II , when he started making big money, that he could do 4 movies before hitting the 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 cuve. I couldn’t shoot my way out” The “Gipper” Bonzo For rich people , there would be a disincentive to quit working when they hit the top marginal tax rate. For most workers , this was not the case . R eagan
Comparing the Laffer Curve to Robin Hood <ul><li>Arthur Laffer illustrated his supply-side views with a story relating to Robin Hood , who stole from the rich to give to the poor . Laffer likenedpeople traveling through Sherwood Forest to taxpayers , whereas Robin Hood and his band of merry men were 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?” </li></ul>His answer was, “No.” Taxpayers will avoid Sherwood Forest to the greatest extent possible. They will lower their taxable income by reducing work hours, retiring earlier, saving less, and engaging in tax avoidance and tax evasion activities. Robin Hood and his men may end up with less revenue than if they collected a relatively small “tax” from each traveler for passage through the forest. The “rich” Sherwood Forest Robin Hood