Reaganomics and Late 1980’s Economic Conditions
On the evening of August 18, 1988, then Vice President George HW Bush had reached the apex of his presidential campaign. While addressing the issue of taxes, President Bush seized the moment to set himself apart from the opposing democratic candidate Michael Dukakis. With his cadence perfected and his words synchronized to accentuate the crowd’s reaction, Vice President Bush uttered six words that marked the legacy of his presidency: “read my lips, no new taxes.” Little did the then Vice President know, he was about to inherit the brunt of his predecessors policies, and that the rising tide of growth that the United States experienced in the late 1980’s was about to subside.
Economic growth during the 1980’s was a result of carefully orchestrated financial engineering under President Ronald Reagan, the economic philosophy known as trickle-down economics grew into popularity and spawned the term “Reaganomics.” Reaganomics emphasized a laissez-faire approach whereby business and wealthy were given tax breaks and it was expected that the financial benefits would eventually trickle-down to the rest of society. It was this philosophy that set the backdrop for the US economy in the early 1980’s. The US economy, riding on the back of an increasing annual Real GDP, averaged 4.4% since 1980. With consumer spending fueled by reductions in the Federal Tax code as a result of the 1981 Economic recovery act of 1981 federal income taxes were reduced by 25% over the following three years.
In what became known as the second round of Reagan tax cuts, the Tax Reform Act of 1986 was introduced to:
- Close loopholes in the tax code
- Simplify the US tax code by consolidating tax brackets which included; lowering taxes on the highest income bracket from 50% to 28%, while increasing taxes on the lower income individuals from 11% to 15%
- Increase taxes on businesses
- Change accounting on depreciation of investment tax credits
With an emphasis on emphasis on federal monetary policy, deregulation, and expansion of free trade, many would argue that Reagan’s policies created a period of economic expansion that resulted in America’s greatest sustained wave of prosperity; however there were consequences that would spill over into the Bush era.
From 1980 to 1990, the United States witnessed a 65% increase in US housing prices . Although this appeared to be a positive result, the negative side effect was that inflation increased along with consumer goods and services, resulting in an average 4.5% CPI-U increase year over year from 1988 to January 1990 . In February 1988, the Federal Open Market Committee (FOMC) decided to lower its objectives for monetary growth as a result of sluggish consumer spending and uncertainties in a transition from a consumer-driven to an export driven expansion . High inflation also caused the Federal Reserve Bank to restrict the monetary supply by increasing the fed funds rate. In addition, the increase of capital also put additional pressure on the banking and credit system and contributed to slower economic growth. Ultimately, from February 1988 to May 1989 the FRB raised the target Fed Funds rate from 6.5% to 9.75%.
By the late 1980’s the reduction in monetary supply effected economic growth. Real GDP growth also slowed to 0.9% in the third quarter of 1989, leading the Fed to react to this slowdown by cutting interest rates in October of 1989. However, the US financial and economic system was already fragile at this point especially as the savings and loan crisis was still applying pressure to the credit markets.