Keynes Is Dead, Long Live Reaganomics 2.0

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Keynes Is Dead, Long Live Reaganomics 2.0

It's one thing to discuss economic models in the sterile environment of a classroom.  It's quite another thing to see them played out in the real world, with real-life consequences. 

The battle over which model is best at assuring prosperity and dealing with crises has been ongoing for decades.  But recently, the pace of change has quickened and the policy pendulum has swung away from demand-side Keynesian economics and toward supply-side "Reaganomics."  To put the current trend into perspective, let's review some recent history.   

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From 1933 to 1980, the ideas of John Maynard Keynes dominated American economic policy.  Keynesian economic policy focuses on stimulating demand via government expenditures and transfer payments.  FDR and his successors, including Eisenhower, Nixon, and Ford, accepted this version of economic reality.

But by the late '70s, in the face of a stalled economy, the ability of the government to manage the business cycle with fiscal policy was increasingly brought into question.  Enter Ronald Reagan.

Reagan and his successors replaced Keynesian policies with so-called "supply-side economics," based on the work of economists such as Milton Friedman and Arthur Laffer.  This philosophy emphasized policies that removed barriers to "free market optimization" of the supply of goods and services.  These supply-side policies relied on low taxes, minimal regulation, and individual responsibility.  The economy quickly responded with a surge of economic growth.

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Then, as a further validation of the failure of "central planning," the cornerstone of Keynesian theory, — the Warsaw Pact economies — collapsed in the early 1990s.  Almost overnight, the formerly communist states of Eastern Europe were integrated into the Western-style global economy. 

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At first, the shift to supply-side economics in the U.S. operated exactly as one would expect from a textbook perspective.  The rise of "free markets," coupled with the maturing information economy and the opening of global markets, led to a decline in organized labor, defined benefit pension plans, and the other "nanny-state crutches" that Americans had come to rely on.  Right on cue, this decline created a greater need for people to take responsibility for their own financial needs by investing in stocks, real estate, and other vehicles.  So far, so good...

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