Office of Management and Budget Director Mick Mulvaney outlined the administration’s strategy for growth in a July 4th op-ed for the Wall Street Journal. According to Mulvaney, the administration seeks to:
Make America Great Again. But what does this mean? It means we are promoting MAGAnomics—and that means sustained 3% economic growth.
As Mulvaney admits, most economists think this goal is unrealistic. To be more precise, there are no small, or even medium scale changes in policy that could achieve such growth rates. There are some massive changes that could do the trick—a dramatic increase in immigration rates, for example—but the administration has ruled those out. Moreover, pure luck could send us massive waves of growth in the form of a new tech or biotech development that changes the economic landscape. That, however, isn’t under the administration’s control. The policies which are under their control and which they are willing to consider are not nearly powerful enough to achieve this goal. Nonetheless, Mulvaney is undeterred.
We heard the same pessimism 40 years ago, when the country was mired in “stagflation” and “malaise.” But Ronald Reagan dared to challenge that thinking and steered us to a boom that many people thought unachievable. In the 7½ years following the end of the recession in 1982, real GDP grew at an annual rate of 4.4%.
Note that the “many people” here does not include prominent economists, who not only thought a revival of growth was possible, but almost inevitable once the Fed took the breaks off. Milton Friedman laid out what to expect with his famous plucking analogy.
In terms of our analogy, every now and then the money string is plucked downward. That produces, after some lag, a downward movement in economic activity related in magnitude to the downward movement in money. The money string then rebounds and that in turn produces, after some lag, an upward movement in economic activity, again related to the upward movement in money. Since the downward and subsequent upward movements in money are correlated in amplitude with one another so are downward and subsequent upward movements in economics activity.
What Friedman is telling us is that big monetary contractions will produce big economic contractions followed by big economic booms. Could something like that have been at work following the 1982 recession? That is indeed the case.
In a 2014 Brookings paper, William Gale and Andrew Samwick review research by Marty Feldstein, Reagan’s own Chair of the Council of Economic Advisors.
Feldstein (1986) provides estimates indicating that all of the growth of nominal GDP between 1981 and 1985 can be explained with changes in monetary policy. Of the change in real GNP during that period, he finds that only about 2 percentage points of the 15 percentage point rise cannot be explained by monetary policy. But he also notes that the data do not strongly support either the traditional Keynesian view that the tax cuts significantly raise aggregate demand or traditional supply-side claims that they significantly increase labor supply. He finds, rather, that exchange rate changes and the induced changes in net exports account for the small part of growth not explained by monetary policy. Feldstein and Elmendorf (1989) find that the 1981 tax cuts had virtually no net impact on economic growth. They find that the strength of the recovery over the 1980s could be ascribed to monetary policy. In particular, they find no evidence that the tax cuts in 1981 stimulated labor supply.
That is, the administration’s policy was responsible for essentially none of the boom. All of it was the result of monetary policy. What’s striking here is that Reagan was facing an era of much higher marginal tax rates, a tax code itself which introduced significant complexity into the economy, and he was willing to finance the fix with deficit spending. All of that should have been strongly procyclical. Yet, the dominant force—so dominant that it appears to have overridden everything else—was monetary policy.
The lesson here is that improved policy can create a more open and entrepreneurial society. The differences in very long term growth rates across countries are striking and powerful. However, big one time pushes orchestrated by the White House and Congress rarely produce anything substantial. It is far more beneficial to play the long game by setting stable rules, expanding trade, and opening our markets to goods and ideas from abroad.