Regonomics of the United States - Essay Example

Regonomics Regonomics refers to the economic policies adapted by Former US President Ronald Reagan during the era of 1980s. This was an era dominatedby cold war between US and USSR and amid such political tension and conflict, Ronald Reagan attempted to provide an alternative to the economic policy making in US. Four important pillars of this policy included the reduction in government spending, reduction in the income and capital tax marginal rates, reduction in the intervention of government into the markets as well as to put strict control over money supply in order to control inflation. Based on these four fundamentals, Reagonomics attempted to make a policy shift from the previous regimes in US which mostly focused on alternative economic policies. It has been argued that Reagonomics delivered on most counts due to the fact that it brought wider scale changes into the tax code of the country and brought changes in the way business taxes were levied in the country. Further, this was also considered as the most serious attempt in US to make a shift into economic policies of the country as it was declared that only through controlling the growth of the government, can a country grow and prosper. Reagonomics worked in the sense that it reduced the government spending and rationalized the tax rates which offered relatively more space to the businesses to work and invest into their research and development thus preparing themselves for meeting future challenges of the market economy and other competitive challenges. It is also argued that the unemployment during this era substantially reduced from 7% during 1980 to 5.4% in 1988. (Niskanen, 1988). It is also important to note that during that era, tax collections improved and as a result of this, the overall government outlay increased despite the fact that Reagan attempted to reduce the government spending. The criticism of Reagonimics is however, based upon the notion that US economy, before the Reagan era was facing economic depression therefore the room for the improvement was relatively large. As such, according to Paul Krugman, Reaganomics basically attempted to exploit that available gap to show better performance during that era. (KRUGMAN, 2008). Accordingly, this was an era where rich got richer whereas most of the average Americans suffered and their standard of living further declined and reached to a level which caused immediate recession when Reagan and Bush Senior left the stage. This argument by Krugman therefore is based upon the notion that the distribution of income was largely skewed in favor of high income individuals and ordinary American citizens were not able to raise their overall standard of living. This disparity between the two factions of the economy therefore resulted into subsequent decline in economic activity. The above discussion therefore indicates that the Reaganomics worked in certain ways but failed to produce results in more consistent and produce better performance. Probably its most important achievement was the change in the tax code of the country as well as the changes in the government spending. Effect of Sharp Rise in Oil Prices To assess the effect of sharp rise in oil prices, it is important to assess as to whether the change is permanent or not? In short run prices will tend to increase and resultantly will add to the inflation in the economy. As a result of this, money market will adjust itself to the higher interest rates in order to contain the inflation and bring back the equilibrium position. Since money supply remains fix, an upward increase in the prices will force the increase in the interest rates in short run. This increase in the interest rates will than may contribute towards the decrease in the inflation rate within the economy. In goods market, due to increase in the prices of oil, aggregate supply will tend to increase but since it is assumed to be fixed therefore there will be no adjustment in goods market. However, since inflation will increase therefore the nominal wage rates will increase too in the long run. In short run both will remain same and only adjustment will take place in money market. In long run, if the changes are permanent, both the goods market as well as the money market i.e. IS and LM curve will shift and the economy will reach a new equilibrium point. This new equilibrium point will therefore indicate that changes which may have taken place in all the markets and how prices as well as the interest rates responded to this change. Philips Curve and Expectations Philips curve shows the relationship between the unemployment and inflation and indicates an inverse relationship between the two. Philips curve can be better explained if the impact of the expectations is also taken into consideration. It is assumed that Philips curve is not fixed therefore when there is an increase in the inflation rate, people will expect that the prices will increase. Under the adaptive expectations theory, time lag involved will be up to three years before people will be clearly able to anticipate the changes and adjust towards the increase in the prices. This will therefore cause the Philips curve to shift upwards to reflect the change in the inflation rate however, once people fully anticipate the higher inflation rates there will be no changes in the output as well as the employment level. Rational expectations theory however, indicates that the overall reaction time will be shorter and people will adjust to the changes more rapidly. Thus the major contrasting point between the two theories lies in the assumption that the overall reaction time will be shorter however, both the theories indicate that people will finally adjust to the anticipated changes in the inflation rates and once expectations are fully anticipated there will be no changes in the output as well as employment level with the increase in the inflation rates. Once this is achieved, all the policy efforts to bring in more inflationary policies will fail to yield the desired results in the economy. (Gwartney, Stroup, Sobel, & McPherson, 2008) Bibliography 1. Gwartney, J. D., Stroup, R. L., Sobel, R. S., & McPherson, D. (2008). Macroeconomics: Public and Private Choice. New York: Cengage Learning. 2. KRUGMAN, P. (2008, January 21). Debunking the Reagan Myth. Retrieved October 16, 2010, from The New York Times: http://www.nytimes.com/2008/01/21/opinion/21krugman.html 3. Niskanen, W. A. (1988). The Concise Encyclopedia of Economics. Retrieved October 16, 2010, from Library of Economic Liberty: http://www.econlib.org/library/Enc1/Reaganomics.html Read More