Conservatives praise Kennedy

Economic Policies for the 21st century (e21) at the conservative Manhattan Institute, that also houses the SOMC (Shadow Open Market Committee) writes “KENNEDY: THE FIRST SUPPLY-SIDE PRESIDENT?:

“It is a paradoxical truth that tax rates are too high and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now … Cutting taxes now is not to incur a budget deficit, but to achieve the more prosperous, expanding economy which can bring a budget surplus.”

– President John F. Kennedy (November 20, 1962)

President John F. Kennedy knew that in order for the economy to grow and generate jobs, Congress would need to lower tax rates. He believed in the simple principle that when people have more money, they spend it, generating additional economic activity and tax receipts. While he pushed for reform during his presidential campaign and throughout his presidency, the first of his proposed tax cuts were not passed until February 26, 1964, after his death.

Kennedy proved to be a visionary in fiscal policy. Not only did lower tax rates lead to higher tax revenues, which increased from $94 billion in 1961 to $153 billion in 1968, but lower rates resulted in a declining unemployment rate. This was due in part to additional consumer spending, as well as businesses spending the money they saved on capital investment and hiring more workers—while taking additional entrepreneurial risk.

Gross domestic product grew at 5.8 percent in 1964, 6.5 percent the following year, and 6.6 percent the year after that. Individuals benefitted from finding jobs and having confidence that the economy would continue to improve.

And show this chart:

Kennedy_1

Kennedy did not live to see his tax plan enacted. We will never know how far tax rates would have dropped under his leadership, but we do know that future presidents, such as Ronald Reagan and George W. Bush, followed his leadership on tax reform with similar results. The American people benefitted as well, and should thank the 35th President on the 50th anniversary of his assassination for promoting sensible policies to turn the economy around.

This is a very partial (and so incomplete) view of Kennedy and his times.

The 1960s view, informed heavily by the Great Depression, the ever-present threat was that of economic entropy, in the form of recession and possibly depression, and of business losses that discourage investing, thus becoming a self-fulfilling prophesy.  Economic gloom gathers mass, unless actively dispelled.  Anyone who had lived through the Great Depression, and then the World War II boom, would probably assent to that.

And even if an economist did not fear a self-generating recession, a buttressing view was that recessions marked a shortfall from potential, not a business cycle above and below an optimum output level. Why endure shortfalls?

In this context, monetary policy became a sidekick to White House planners and fiscal stimulus, according to Okun: “The stimulus to the economy also reflected a unique partnership between fiscal and monetary policy. Basically, monetary policy was accommodative while fiscal policy was the active partner. The Federal Reserve allowed the demands for liquidity and credit generated by a rapidly expanding economy to be met at stable interest rates”.

The charts below include the chart above and others that help put it into context:

Kennedy_2

It appears that potential output calculations by the economists at the CEA were too optimistic relative to potential output calculations made by the Congressional Budget Office (CBO) available today. In fact, by 1965, the year after the tax cut was enacted, the economy was beginning to overheat, and creating what may be called a “demand-pull” inflation. Both nominal spending and real output began to grow above potential levels. This is confirmed by what happened to inflation and unemployment, where the continuing fall in unemployment is indicative that the rise in inflation was not expected.

Regarding the Kennedy quote above, perhaps it is not too cynical to observe that in the case of tax cuts, or more federal spending, that the White House and members of Congress may have had constituents and lobbyists in mind, as much as macroeconomic policy.  To have deficits sanctioned as “good policy” may be akin to informing an alcoholic that drinking red wine is actually salubrious.

Not surprisingly, monetarists were not impressed with the 1960s style of macroeconomic policymaking, including the tax cuts (which later would become right-wing orthodoxy as the fuel for economic growth). In a debate with Walter Heller (President Kennedy´s first CEA Chairman) on “Monetary vs. Fiscal Policy” (1969), Milton Friedman argued:

“…So far as I know, there has been no empirical demonstration that the tax cut had any effect on the total flow of income in the US. There has been no demonstration that if monetary policy had been maintained unchanged…the tax cut would have been really expansionary on nominal income….”

The uninhibited expansionist fiscal and monetary policies of the 1960s—but especially the monetary—had telling effect, and inflation, and thus interest rates, began to rise by 1965. The next chart shows that when nominal spending “took off”, interest rates and inflation followed suit.

Kennedy_3

At that point the policymakers began to have doubts. According to Arthur Okun:

“In 1965 the nation was entering essentially uncharted territory. The economists in government were ready to meet the welcome problems of prosperity. But they recognized that they could not provide a good encore to their success in achieving high-level employment.”

And as Gardner Ackley, then CEA Chairman, put it a talk entitled the “The Contribution of Economists to Policy Formation” in December 1965:

“…The plain fact is that economists simply don´t know as much as we would like to know about the terms of trade between price increases and employment gains (i.e., the shape and stability of the Phillips Curve). We would all like the economy to tread the narrow path of balanced, parallel growth of demand and capacity utilization as is consistent with reasonable price stability, and without creating imbalances that could make continuing advance unsustainable. But the macroeconomics of a high employment economy is insufficiently known to allow us to map that path with a high degree of reliability…It is easy to prescribe expansionary policies in a period of slack. Managing high-level prosperity is a vastly more difficult business and requires vastly superior knowledge. The prestige that our profession has built up in the Government and around the country in recent years could suffer if economists give incorrect policy advice based on inadequate knowledge. We need to improve that knowledge.”

Some might say that even in 2013, and given macroeconomic policies of our era, we still very much need to improve our knowledge.

One thought on “Conservatives praise Kennedy

  1. Excellent blogging.
    I see the same myopia today when people discuss mainland China. The People’s Bank of China is never mentioned!
    Yet the PBOC has been pro-growth, willing to tolerate inflation in the 3-4 percent range.

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